Moving Average Convergence Divergence (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 trading asset.

Developed by Gerald Appel in the late 1970s, the Moving Average Convergence Divergence indicator tracks price events that have already occurred and is placed into several categories of late indicators (which provide signals based on past price action or data). MACD can be very useful for measuring market momentum and possible price trends and is used by many traders to determine potential entry and exit points.

Before we dive deeper into how MACD works, it is important to understand the concept of moving averages. A moving average (MA), simply put, is a line that represents the average value of previous data in a specified period. In the context of financial markets, moving averages are the most popular indicators for technical analysis (TA) and they can be divided into two different types: Simple Moving Average (SMA) and Exponential Moving Average (EMA). Although SMA weights all input data equally, EMA gives more weight to the most recent data values ​​(latest price points).

How MACD works

The MACD indicator is created by subtracting two Exponential Moving Averages (EMA) from the main line (MACD line), which will be used to calculate another EMA which represents the signal line.

Moreover, there is a MACD histogram that is calculated based on the difference between the two lines. This histogram, along with the other two lines, fluctuates above and below the center line, also known as the zero line.

Therefore, the MACD indicator contains three elements that move around the zero line:

• MACD line (1): helps determine upward or downward momentum (market trend). This is calculated by subtracting two Exponential Moving Averages (EMA).

• Signal line (2): an EMA of the MACD line (generally the 9-period EMA). Combining analysis of the signal line with the MACD line can help in finding potential turnarounds or entry and exit points.

• Histogram (3): a graphical representation of the Divergence and Convergence of the MACD line. in other words, the histogram is calculated based on the difference between two lines.

MACD line

In general, the Exponential Moving Average is measured according to the closing price of an asset and the periods used to calculate the two EMAs are usually set at 12-period (faster) and 26-period (slower). Periods can be set in different ways (minutes, hours, days, weeks, months), but this article will focus on daily settings. However, the MACD indicator can be set to accommodate different trading strategies.

Assuming a standard time interval, the MACD line itself is calculated by subtracting the 26-day EMA from the 12-day EMA.

MACD line = 12day EMA - 26day EMA

As mentioned, the MACD line ranges above and below the zero line, and this is what signals a crossing of the midline, telling traders when the 12-day and 26-day EMAs are swapping positions.

Signal line

Basically, the signal line is calculated from the 9-day EMA of the main line and provides more depth than the previous move.

By default, the signal line is calculated from a 9-day EMA of the main line and, as such, provides further insights about its previous movements.

Signal Line =9day EMA of MACD line

Although they are not always accurate, when the MACD line and the signal line cross, these events are usually considered a trend reversal signal, especially when they occur at both extremes of the MACD chart (far above or far below the zero line).

Histogram MACD

A histogram is nothing more than a visual history of the relative movements of the MACD line and the signal line. This can be calculated simply by subtracting one from the other:

MACD Histogram =MACD Line- signal line

However, instead of just adding a third line of movement, the histogram is created as a bar graph, making it very easy to read and interpret. Please note that histogram bars have no bearing on the trading volume of an asset.

MACD Settings

As discussed, the basic settings for MACD are based on the 12, 26, and 9-period EMAs - hence, MACD (12, 26, 9). However, some technical analysts and chart readers change the period as a way to make the indicator more sensitive. For example, MACD (5, 35, 5) is one of the most frequently used in traditional financial markets along with longer time frames, such as weekly or monthly charts.

It is important to know that high fluctuations of the digital currency market, increasing the sensitivity of the MACD indicator can be very dangerous as it will generate more false signals and misleading information.

How to read the MACD chart

As the name suggests, the Moving Average Convergence Divergence (MACD) indicator tracks the relationship between moving averages, and the correlation between the two lines can be expressed as convergent or divergent. Convergent when lines move closer to other lines, and divergent when they move away from other lines.

The relevant signals from the MACD indicator are connected to what is known as a crossover, which occurs when the MACD line crosses above or below the center line (center line crossover), or above or below the signal line (signal line crossover).

Note that both center line and signal line crossings can occur multiple times, resulting in many false and deceptive signals - especially in highly fluctuating assets, such as digital currencies. Therefore, one should not rely only on the MACD indicator.

Center line crossing

Center line crossing occurs when the MACD line moves in the positive or negative area. When the line crosses above the center line, a positive MACD value indicates the 12-day EMA is greater than the 26-day. And conversely, a negative MACD will be indicated when the MACD line crosses below the Center Line, which means the 26-day average is higher than the 12-day average. In other words, a positive MACD line suggests a strong upward momentum, whereas a negative line may indicate a strong downward impulse.

Crossing signal line

When the MACD line crosses above the signal line, traders often interpret it as a buying opportunity (entry point). On the other hand, when the MACD line crosses below the signal line, traders often consider it a selling opportunity (exit point).

While crossing signals can be very helpful, they are not always reliable. We should also consider their position on the chart as a way to reduce risk. For example, if the crossover suggests buying but the MACD line indicator is below the center line (negative), market conditions can be considered bearish. Conversely, if a crossing line signal indicates a potential sale, but the MACD line indicator is positive (above the zero line), market conditions will be more bullish. In this scenario, following a sell signal is more risky (considering the larger trend).

MACD and Price Divergence

Along with center lines and signal line crossovers, MACD charts can also provide insight through divergence between the MACD chart and an asset's price action.

For example, if the price action of a digital currency is making higher highs at a time when the MACD is making lower highs, we would have a bearish divergence, indicating that although the price is increasing, the upward momentum (buying impulse) is not as strong. Bearish divergences are usually interpreted as selling opportunities because they usually precede price reversals.

Conversely, if the MACD line forms two rising low lines and is parallel to two falling low lines in the asset price, then this is considered a bullish divergence, which suggests that even though the price is declining, purchasing power remains stronger. Bullish divergences are more common to precede price reversals, can indicate a potential short-term low point (from a downtrend to an uptrend).

Conclusion

When we get to technical analysis, the Moving Average Convergence Divergence oscillation is one of the most useful tools available today. Not only because of its ease of use, but also because of its effectiveness in indicating market trends and market momentum.

However, like most TA indicators, MACD is not always accurate and can provide false and misleading signals - especially in relation to fluctuating assets or in times of trend weakening or sideways price action. Therefore, many traders use MACD with other indicators - such as the RSI indicator - to reduce risk and to confirm deeper signals.