A Comprehensive Guide to the MACD

Hello traders, in this post, we will be talking about how to use the MACD indicator, PROPERLY. I will be going over all of the main indications on how to use this tool and most importantly, how to interpret it. The MACD is another most commonly used tool within the trading community, and if used right with other indicators, this tool can be incredibly useful for deleveraging risk for entries and exits. The MACD is a momentum indicator and stands for "moving average converging divergence" - as it requires moving averages as its main input.

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In this post, we will only refer to the price action with the default settings (12 and 26 EMA).

The MACD is simply built on two major line components, the 1) MACD line, and the 2) Signal line.

The MACD line and signal line is shown in the example below. The MACD line is defined with two lines where one reacts faster to price changes.

The MACD Histogram
The MACD Histogram is the difference between the MACD line and the signal line, also shown in the example below. The bigger the gap between the lines, then the higher the bars that the MACD histogram will show within the indicator.

The MACD in general is a MOMENTUM indicator that shows the relationship between the two moving averages as explained above. The MACD line is calculated by taking the difference between the longer and short term period exponential moving average. Exponential averages are used because they respond quicker to price change and is weighted on recent price action.

How It Works

Again, if you open up your MACD indicator from the tool list, you do not need to change the default settings, as they default settings for the EMA is already set at 12 and 26, respectively as the main exponential moving average. As the two moving averages move away from each other, the MACD line will rise or fall as shown in the diagram above.

When the two moving averages cross, there is a corresponding cross of the zero level by the MACD line.

When the signal line and MACD line averages cross, there is a corresponding cross of the zero level by the MACD histogram.

The most important way to interpret it is understanding the interaction between the two MACD lines as well as their positions relative to the zero line. When the MACD is above the zero line, it indicates that the momentum is bullish. When the MACD line is BELOW the zero line, the momentum is then considered to be bearish.

In summary, the MACD is used in one of three ways:

1) Crossovers - this is generated when the MACD lines cross below the signal line. These either create a buy or sell signal when it crosses to the upside/downside. In addition, the locations of the crossovers in relation to the zero line are helpful for determining the buy or sell signals. Bullish signals are more significant when the crossover takes place below the zero line. The CONFIRMATION takes place when both lines cross ABOVE the zero line. Crossovers work best when you are in a TRENDING market. You can still have bearish crossovers within a bullish market, often creating false signals for new traders.
2) Overbought/Oversold conditions
3) Divergences

The best time frame for the MACD does not exist. This would be completely up to your personal preference; however, daily signals (1D timeframe) are more significant than shorter timeframes because they carry more weight. A good tip is to track the behavior of the MACD on a daily chart, and confirm the trade with the WEEKLY timeframe.