The Moving Average Convergence Divergence (MACD) indicator is a momentum oscillator widely used in trend-following trading strategies. It consists of two lines: the MACD line and the signal line. When the MACD line crosses above the signal line, it indicates a bullish trend. Unlike most technical indicators that provide single pieces of historical price data, the MACD is a versatile 2-in-1 indicator that simultaneously assesses trend direction and strength.
Invented by Gerald Appel in 1979, the MACD helps investors determine the direction, length, strength, and momentum of an asset’s price.
How MACD Works?
- The MACD line is derived by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA
- The signal line is a 9-period EMA.
The MACD is a trend-following momentum indicator within the oscillator family of technical indicators. It offers the ability to:
- Evaluate the current trend direction (bullish or bearish) and predict potential price movements based on the relationship between two moving averages.
- Measure the rate of change in cryptocurrency prices, indicating the speed or momentum of the trend, which is useful for assessing the strength or weakness of a crypto trend.
- On a price chart, the MACD indicator appears as an oscillator with two moving averages, accompanied by an MACD histogram that overlays the two averages.
To comprehend MACD, one must first understand the concept of Moving Averages (MA), representing the average value of data over a specific period on a graph. Traders classify MAs into two main types: simple moving averages (SMAs) and exponential moving averages (EMAs). MACD utilizes EMAs, which emphasize recent data and are more relevant for making buy or sell decisions. The simplicity of the MACD indicator makes it suitable even for beginners. However, it’s important to remember not to base trading decisions solely on one signal. MACD can complement other indicators like Stochastic or RSI.
The MACD indicator consists of three key components:
- The MACD Line: The fastest moving average (short-term EMA) represented in blue. It’s calculated by subtracting the 26-day EMA from the 12-day EMA.
- The Signal Line: The slowest moving average (long-term EMA) shown in red. It’s a 9-day EMA of the MACD Line and helps identify price action turns.
- The MACD Histogram: It fluctuates above and below a zero line, indicating bullish and bearish momentum readings. The histogram is the difference between the MACD line and the signal line. A positive histogram indicates MACD is above the signal line, and vice versa.
Interpreting MACD Signals
The MACD indicator offers traders three main types of signals to identify potential buying and selling opportunities:
- Signal Line Crossovers:
One of the most straightforward signals to utilize is the signal line crossover. As mentioned earlier, the signal line represents the moving average (MA) of the MACD line, causing it to lag behind. When these two lines visibly cross over each other, it indicates the possibility of strong price movements. The positioning of these lines determines whether the crossover is bullish or bearish:
- A bullish crossover occurs when the short-term Exponential Moving Average (EMA) crosses above the long-term EMA.
- A bearish crossover occurs when the short-term EMA crosses below the long-term EMA.
- Zero Line Crossovers:
For enhanced signal reliability, it’s essential to consider the general trend along with the crossover. If the overall trend aligns with the crossover, the signal’s strength is higher.
Similar to the previous signal, the zero-line crossover involves the MACD line crossing the zero level, instead of the signal line. When the MACD line turns positive by crossing above the zero line, it indicates a bullish trend. Conversely, when the MACD line crosses below the zero line and becomes negative, it suggests a bearish trend.
Note: The farther the MACD line moves away from the zero line, the stronger the trend becomes.