Wouldn’t it be great if you knew what is MACD and how to use it properly in your analysis?
We bet it would!
The MACD indicator is useful to both new and professional traders of the crypto and stock market.
And when you pair this indicator with RSI, you can spot better buying and selling opportunities.
It’s one of the best trading indicators to confirm your analysis is on track.
That being said, let’s teach you how to interpret MACD, differentiate between a bullish and bearish MACD crossover, and the best time frame to use MACD.
So here we go!
What is MACD Indicator?
MACD denotes Moving Average Convergence Divergence.
This is a trend following and momentum indicator that features two moving averages (MAs) and a histogram.
Now get this!
The MACD as a trend following indicator shows you the current market direction (uptrend, downtrend, or range).
This trend is represented by the two MAs of the indicator.
As a momentum indicator, the MACD tells you how fast price is moving or volatility of the market.
This momentum is shown on the histogram.
On that note, there are three main components of the MACD and these are the MAs and a histogram.
The two MAs are called the MACD line (this is the faster MA and often indicated in blue color) and the signal line (this is the slower MA often represented in orange).
So, what is MACD line?
It is a line calculated with the formula: 12-day EMA – 26-day EMA.
The signal line is described as the 9-period EMA of the MACD line.
And the histogram is the difference between the MACD and signal line.
While these descriptions may sound a bit technical, take a moment to wrap your head around it.
What type of Indicator is MACD?
MACD is a lagging indicator since the data it uses is based on historical price movement.
Understanding Moving Average Convergence Divergence
Understanding the Moving Average Convergence Divergence indicator can significantly improve your analysis.
Recall that this indicator has three major parts thus, pay close attention to each component during your analysis.
Here’s how to interpret the MACD and use it correctly while trading the spot and futures market:
1. Bullish and Bearish MACD Line Crossovers:
The oscillators or lines of this indicator tend to cross over each other and each cross has a meaning.
It’s a bullish crossover when the MACD line moves over the signal line.
This is a buy signal hinting you should take a position in the market.
This bullish move also indicates that the market has changed its trend from a downtrend to an uptrend.
On the contrary, a bearish crossover is when the MACD line goes below the signal line.
This movement is a sell signal indicating that it’s time to take profit or hold no position.
It also indicates that the market’s trend could change from upwards to downwards.
Now it’s important to note that these crossovers happen in all time frames and as such, the higher the time frame, the more reliable the crossover.
Here’s an example:
If you’re trying to determine if the market is in an uptrend, you should be looking at crossovers on higher time frames like the D1 and D4.
And when you’ve ascertained that the market is in an uptrend, you can then proceed to check if the market is at a key level (support on a trendline or moving average) before taking a position.
Thus, you won’t rely only on the bullish crossover of the MACD to make an entry, but on price action and other indicators (SMAs or EMAs and RSI).
It’s also worth noting that each time a crossover occurs, the histogram disappears.
Why is that?
The difference between the MACD line and signal line during the cross is 0, hence, the histogram plots 0.
2. Bullish and Bearish Divergence of the MACD:
The MACD line and signal line often form peaks (highs) and troughs (lows), which you can also use to your advantage.
If the movement of both MACD lines diverges from price movement, it indicates a bullish or bearish signal.
How can you determine if it’s a bullish or bearish divergence?
Let’s guide you through the whole process.
Do the following for a bullish divergence:
- Focus on the lows of price and the indicator.
- Draw a trend line on the MACD troughs.
- Draw a trend line support for price
- Make a comparison between the direction of the drawn lines.
If the direction of the line on MACD faces up or indicates an uptrend (higher lows) while the line on price indicates a downtrend (lower lows), then you have a bullish divergence of the MACD.
This is a buy signal, which also indicates the market is oversold.
Do the following for a bearish divergence:
- Focus on the highs of price and the indicator.
- Draw a trend line on the MACD peaks.
- Draw a trend line at price resistance.
- Make a comparison between the direction of the lines.
You have bearish divergence when the MACD trendline points downwards (lower highs) while the trend line drawn at price resistance is facing upwards (higher highs).
This is a sell signal.
3. Positive and Negative MACD:
Take a closer look at the MACD indicator on your TradingView, Tabtrader, or whichever trading app you use.
You’ll notice that numbers are plotted by the side of the histogram.
Read Also: How to Read Candlesticks Like a Pro
Now if the two MACD lines are below 0, then we have a negative MACD while a positive one is formed when both lines of the indicator are above 0.
A positive MACD indicates that the uptrend is strengthening while a negative one indicates increased downward movement.
Therefore, one of the key uses of the MACD is to determine strength of the market..
4. Momentum Changes on the Histogram:
The histogram reveals the pace at which price is moving.
This component gets wider with larger candles when volatility is high but tightens with smaller candles when volatility is low.
How can this help in your analysis?
Each time volatility contracts, you can expect an expansion at a later time.
Thus, it’s ideal to make entries when volatility contracts and take profit when volatility expands.
Put simply, you should be looking for entries when the histogram bars are small & flat and not after they’ve grown extremely large.
Your entries should only be made when the market has broken a key level such as support and resistance.
- Long at the breakout of a buildup into resistance and when the histogram bars are flat.
- Strategically position your stop loss at the lows of the buildup.
- Short after a breakout of a buildup into support and when the histogram bars are tight and flat.
- Set your stop loss at the highs of the buildup.
Similarly, do not long when the MACD histogram has formed large green candles at the peak since a lot could have happened already.
Instead, do the opposite by shorting the peak since momentum is extended already and a reversal may be underway.
The same goes when the histogram has formed a trough with large bearish candles. You should not be looking to short but long the market from a key level.
What is the Best Time Frame for MACD
Are you wondering what is the best time frame for the MACD indicator?
Then here’s what you need to know:
1. Determine the Trend:
The best time frame is dependent on whether you’re day trading or scalping.
But first, you need to determine the trend using a higher time frame such as D1.
Once you’ve identified the trend, you can then proceed to any time frame depending on the trading strategy you’re employing.
Here’s where we’ll implement what you’ve already learnt in the previous section of this guide.
Recall that the MACD gives off a buy signal when the MACD line crosses above the signal line but indicates a sell when the same blue line goes below the signal line.
Now hold that thought!
2. Choose a Timeframe Based on Your Trading Strategy:
If you’re day or swing trading and looking to close your trade on the same day, then use multiple time frames such as D1 and H4 in your analysis.
Let’s show you an example:
The MACD crossover on H4 would present good buying and selling opportunities for a day trader.
However, when the MACD on D1 is bullish, only look for buy signals on the H4 chart but when the MACD on D1 is bearish, only look for sell signals on H4.
This trading method is called multiple time frame analysis with respect to higher time frame.
Here’s another example:
The MACD crossovers on time frames such as M5, M10, and M30 would prove useful if you’re scalping.
But you need to know a higher time frame to pair with any of these.
Therefore, use the strategy of a Factor of 4 to 6.
That is, multiply your chosen time frame by 4 or 6 to know the higher time frame to make reference to.
For instance, if you want to scalp with M5, your higher time frame will be M20 (5 * 4) or M30 (5 * 6).
We’ll use M30 since most trading platforms support this time frame.
- When the MACD on M30 is bullish, you’ll only look for buy signals on the M5 MACD.
- When the indicator on M30 is bearish, you’ll only look for sell signals on the M5.
You can also use the MACD Triple strategy to improve the way you trade.
What’s this strategy about?
It involves using three time frames in your analysis.
Let’s say you’re scalping on the M15 time frame, use the H4 and H1 time frames to determine the trend and filter out some noise.
Do the following:
- If the indicator on H4 and H1 is bullish, then only look for long entries on the M15 MACD chart.
- If the indicator on H4 and H4 is bearish, only look for short entries on M15 chart.
- If the indicator on H4 is bullish but bearish on H1, you can ignore both signals.
Understanding these concepts allows you to manipulate different time frames without looking for the best MACD settings.
Now that you know what is MACD and how to use it, the ball’s now in your court to better your trades with this indicator.
It’s quite easy to use this indicator and even combine it with price action.
Therefore, master the guidelines above to start using this indicator like a pro.
And don’t forget to combine the indicator with others to determine the direction and strength of the market.