Moving Average Divergence and Convergence (MACD) is an oscillator-type indicator that is widely used by traders for technical analysis (TA). MACD is a trend-following tool that uses moving averages to determine the momentum of a stock, cryptocurrency, or other tradable asset.
Developed by Gerald Appel in the late 1970s, the Moving Average Convergence Divergence indicator tracks price events that have already occurred and thus falls into the category of lagging indicators (which provide signals based on past or current price movements). The MACD can be useful for measuring market momentum and possible price trends and is used by many traders to identify potential entry and exit points.
Before diving into how MACD works, it is important to understand the concept of moving averages. A moving average (MA) is simply a line that represents the average of previous data over a specific period. When it comes to financial markets, moving averages are among the most popular indicators for technical analysis (TA), and they can be divided into two different types: simple moving averages (SMA) and exponential moving averages (EMA). While SMAs weight all inputs equally, EMAs give more weight to the most recent data (newer price points).
How does MACD work?
The MACD indicator is generated by subtracting two exponential moving averages (EMAs) to create a major line (MACD line), which is then used to calculate another EMA representing the signal line.
Additionally, there is a MACD histogram which is calculated based on the differences between these two lines. The histogram, along with two other lines, fluctuates above and below a center line, also called the zero line.
Therefore, the MACD indicator consists of three elements moving around the zero line:
MACD Line (1): Helps identify upward or downward momentum (market trend). It is calculated by subtracting two exponential moving averages.
Signal line (2): EMA of the MACD line (usually a 9-period EMA). A combined analysis of the signal line with the MACD line can be useful in identifying potential reversals or entry and exit points.
Histogram (3): A graphical representation of the divergence and convergence of the MACD line and the signal line. In other words, the histogram is calculated based on the differences between two lines.
MACD line
In general, exponential moving averages are measured according to the closing prices of the asset, and the periods used to calculate the two EMAs are typically set to either 12 periods (faster) or 26 periods (slower). The period can be configured in different ways (minutes, hours, days, weeks, months), but this article will focus on daily settings. However, the MACD indicator can be customized to suit different trading strategies.
Assuming standard time ranges, the MACD line itself is calculated by subtracting the 26-day EMA from the 12-day EMA.
MACD line =12d EMA - 26d EMAAs mentioned, the MACD line fluctuates above and below the zero line, and this is what signals the center line crossing, letting traders know when the 12-day and 26-day EMA are changing their relative positions.
Signal line
By default, the signal line is calculated based on the 9-day EMA of the main line and as such, provides additional information about its previous movements.
Signal line =9d EMA of MACD lineAnd although they are not always accurate, when the MACD line and the signal line cross, these events are usually considered trend reversal signals, especially when they occur at the ends of the MACD chart (much above or much below the zero line).
Histogram MACD
A histogram is nothing more than a visual record of the relative movements of the MACD line and the signal line. It is simply calculated by subtracting one from the other:
MACD histogram =MACD line - signal lineHowever, instead of adding a third moving line, a histogram consists of bars on a graph, making it visually easy to read and interpret. Please note that the histogram bars have nothing to do with the trading volume of the asset.
MACD settings
As stated earlier, the default settings for MACD are based on 12, 26 and 9 day EMAs, hence MACD (12,26,9). However, some technical analysts change the periods to create a more sensitive indicator. For example, MACD (5,35,5) is one that is often used in traditional financial markets along with longer time frames such as weekly or monthly charts.
It is worth noting that due to the high volatility of cryptocurrency markets, increasing the sensitivity of the MACD indicator can be risky because it may lead to more false signals and misleading information.
How to read MACD
As the name suggests, the moving average divergence and convergence indicator tracks the relationship between moving averages, and the correlation between the two lines can be described as convergent and divergent.
However, the corresponding MACD indicator signals are associated with so-called crossovers, which occur when the MACD line crosses above or below the center line (center line crossover) or above or below the signal line (signal line crossover).
Remember that crossings of both the center line and the signal line can occur multiple times, creating many false and tricky signals, especially with volatile assets such as cryptocurrencies. Therefore, you should not rely only on the MACD indicator.
Crossing the center line
A center line crossover occurs when the MACD line moves into a positive or negative area. When it crosses above the center line, a positive MACD value indicates that the 12-day EMA is greater than the 26-day EMA. In contrast, a negative MACD is indicated when the MACD line is below the center line, meaning that the 26-day average is higher than the 12-day average. In other words, a positive MACD line indicates stronger upward momentum, while a negative MACD line may indicate stronger downside bias.
Signal line crossing
When the MACD line crosses the signal line, traders often interpret it as a potential buying opportunity (entry point). On the other hand, when the MACD line is below the signal line, traders tend to view it as a selling opportunity (exit point).
Although signal crossings can be useful, they are not always reliable. It is also worth considering where they are located on the chart to minimize risks. For example, if the crossover calls for a buy but the MACD line indicator is below the center line (negative), market conditions may still be considered bearish. Conversely, if the signal line crossover indicates a potential sell point, but the MACD line indicator is positive (above the zero line), market sentiment may still be bullish. In such a scenario, following a sell signal may carry more risk (given the trends).
MACD and price divergence
Along with the centerline and signal line intersection, MACD can also provide insight into the differences between the MACD chart and an asset's price activity.
For example, if the price activity of a cryptocurrency makes a higher high while the MACD makes a lower one, there will likely be a bearish divergence indicating that despite the price rising, the upside momentum (buying pressure) is not as strong as it was, bearish Divergences are usually interpreted as selling opportunities since they typically precede price reversals.
In contrast, if the MACD line forms two rising lows that coincide with two falling lows in the asset's price, then this is considered a bullish divergence, suggesting that despite the price falling, buying pressure is greater. Bullish divergences typically precede price reversals, which can indicate a short-term bottom (from a downtrend to an uptrend).
Conclusion
When it comes to technical analysis, the Moving Average Divergence Oscillator is one of the most useful tools available. Not only because it is relatively easy to use, but also because it is quite effective in identifying both market trends and market impulses.
However, like most TA indicators, MACD is not always accurate and can produce numerous false and misleading signals, especially in volatile assets or during times of weak trend or sideways price movement. Consequently, many traders use MACD along with other indicators such as RSI to reduce risks and further confirm signals.