What Is MACD Indicator?
MACD indicator is indisputably very popular momentum(trend) indicator used in technical analysis in stock market. MACD is a acronym used for Moving Average Convergence Divergence.
MACD indicator is a combination of two different exponential moving average.
Out of the two moving averages one is of shorter time period(12day EMA) and the other longer time period(26day EMA). It gets calculated by subtracting 26 day EMA from 12day EMA.
This results in giving a MACD line. After that, a 9day ema also called as signal line is plotted on the top of the MACD line to generate a trigger for buy and sell signal for any stock or index.
One can buy(go long) the security when the MACD(line) crosses above its signal line(9day EMA line) and sell (go short) the security when the MACD crosses below the signal line.
Before we study and understand how to use macd effectively, one need to understand the basics of MACD indicator. This monster guide will help you to answer all you questions related to MACD indicator.
After reading these you do not need to go search on web looking for information and wasting your more precious time. Instead you can focus on your daily trading or investing activity.
So, let us try to understand the MACD(Moving Average Convergence Divergence) indicator and various implementation in trading or investing.
Note: In case you are not aware about what is Moving averages(SMA or EMA) please read this here for better understanding.
How MACD Is Calculated?
The Moving Average Convergence and Divergence (MACD) indicator was developed by Gerald Appel in the late 1970’s. The Moving Average Convergence Divergence indicator tracks pricing events that have already occurred and, therefore falls into the category of lagging indicators.
A lagging indicator provide signals based on past price action or data.
You might be thinking, what would be the use of getting a signal after the event has occurred? Wisely it is better late, than never.
On the other hand leading indicators are wicked for giving false signals and most importantly not all leading indicators are accurate. Therefore, the trader should be highly alert while using leading indicators.
The MACD are useful for measuring market momentum as well as possible price trends and is employed by many traders and investors to identify potential entry and exit points in market.
Here’s the MACD formula:
MACD Line: 12-day EMA minus 26-day EMA
Signal Line: 9-day EMA of MACD Line
MACD Histogram: MACD Line – Signal Line
“12, 26, 9” as the MACD parameters is usually the default setting for most charting software.
Here the The 12 represents the previous 12 bars of the faster moving average. The 26 represents the previous 26 bars of the slower moving average.
The 9 represents the previous 9 bars of the difference between the two moving averages(12,26). This is plotted by vertical lines called a Histogram.
There is a general misinterpretation when it comes to the lines of the MACD. The two lines that are drawn are not moving averages of the price of the stock or index you are trading. Instead, they are the moving averages of the difference between two moving averages.
The Histogram simply plots the difference between the 12 and 26 day moving average.
Let us look to a chart by plotting MACD indicator below to understand it better:
- The MACD line (1): helps knowing upward or downward momentum (market trend).Remember ‘trend is your friend’ this is where the most money stored. We already know, it gets calculated by subtracting two exponential moving averages (EMA).
- The signal line (2): an EMA of the MACD line ( 9-day EMA). This helps you identifying potential triggers for reversals or entry and exit points.
- Histogram (3): It is just a a graphical representation of the divergence and convergence of the MACD line and the signal line. As mentioned above, histogram is calculated based on the differences between the two lines.(Note that the histogram bars have nothing to do with the trading volume of the stock or index).
If you look at the chart above, you can see that, as the two moving averages goes apart, the histogram gets bigger. This is called a MACD divergence because the faster moving average is “diverging” or moving away from the slower moving average.
As the moving averages get nearer to each other, the histogram gets smaller. This is called convergence because the(12 day) faster moving average is “converging” or getting closer to the (26 day) slower moving average.
For those who do not know:
Exponential Moving Average (EMA) is one of the best technical indicator used extensively by traders and investors in stock market. Reason being, exponential moving average (EMA) gives more weight-age to the recent price data as compared to Simple Moving Average (SMA).
EMA is very much similar to SMA as it helps traders to measure trend direction of any security. EMA helps in predicting the future trend, Essentially its a trend direction indicator.
The same EMA we use in creating a macd line and a signal line. Now that you know much about the MACD line, Signal line & MACD histogram let us move to understand the settings.
Note: There is point wasting time in learning about the formula as, these lines get easily plotted on the software terminal you use in just few clicks.
Better we concentrate our time in how to implement MACD while trading or investing. Here is the link to use free charting software online in case you do not have any.
What Is MACD Indicator Best setting for Intraday trading?
There is one thing which is constant in stock market, it is called ‘change, the market is always keep on changing, hence there is no such thing as best MACD setting.
You can try to do different experiments, however it is advisable to use the default “12,26,9” setting.
You can also try and use different time intervals, in case you want to do any sort of experiment. For that you can use
(faster moving average)Short-term intervals – 3, 5, 7, 9, 11, 12, 14, 15-day
(slower moving average)For Long-term intervals – 21, 26, 30, 45, 50, 90, 200-day.
Besides this 9-day and 12-day duration are more popular in short term trends.
Where as 26-day, 50-day intervals are more used for long term trends. MACD (5, 35, 5) is also used by many fundamentalist and technical specialist around the world. One can choose the chart time frame(minutes, hourly, daily, weekly or yearly).
How to Trade Using MACD Indicator?
Before we understand how to use the MACD indicator, let us look at the chart below to segregate, MACD Line, Center line, signal line and histogram.
As, you can see in the chart(day) above (SBI BANK), we have plotted the MACD indicator, below the chart you see the settings i have done to get those plotted.
One important thing that we missed is the central line, which is in between the histogram that you see. When, MACD line move up(bullish) or below(bearish) this central line, it indicates the bullishness or bearishness in the asset.
However there is one problem with the central line:
While waiting for the MACD line to crossover the center line a major move would already be done and perhaps it would be late to enter a trade. To overcome this, there is an improvisation over this basic MACD line, that is what we are using as 9-day ema line.
What Is MACD Indicator Crossover Strategy?
Let me plot MACD indicator on a candlestick graph to help you better understand the crossover strategies.
Center-line also known as (zero line), when you see this on chart it will be reflected as zero. A crossovers happen when the MACD line(black) moves above or below the center line.
When it crosses above the center-line, the positive MACD value indicates that the 12-day EMA is greater than the 26-day.
In contrast, a negative MACD is shown when the MACD line crosses below the center-line, meaning that the 26-day average is higher than the 12-day.
In other terms, a MACD line above the center line suggests a stronger upside momentum, while if it is below the central line it indicate a stronger downside trend.
Note: You can choose any color for plotting a MACD and signal line on chart
Signal line crossover:
When the MACD line (black in above chart) crosses above the signal line(orange), traders often interpret it as a potential buying opportunity (entry point).
On the other hand, when the MACD line crosses below the signal line, traders tend to consider it a selling opportunity (exit point). While the signal crossovers can be helpful, they are not always reliable especially in highly volatile market.
Points to remember:
- The sentiment is bullish when the MACD line crosses the 9 day EMA(signal line). When this happens, the trader should look at buying opportunities
- The sentiment is bearish when the MACD line crosses below the 9 day EMA(signal line). When this happens, the trader should look at selling opportunities
It is also worth considering where they take place in the chart as a way to minimize the risks. For instance, if the signal line crossover calls for a buy but the MACD line indicator is below the center line (negative), market conditions may still be considered bearish.
oppositely, if a signal line crossover indicates a potential selling point, but the MACD line indicator is positive (above the zero line), market conditions are still likely to be bullish.
In such a scenario, following the sell signal may carry more risk (considering the larger trend, or for investment).
The MACD and signal line move above and below the center line or zero line to signal a trend such as overbought and oversold conditions.
When these two EMA move close to each other, it is called convergence, and when they move away from each other ,it is called divergence.
In sideways market. the signals for buy and sell generated will not give enough profit so one can avoid using MACD indicator.
So all in all this is the crux:
The view point is bullish when the MACD line(black) crosses 9 day EMA(orange signal line). Whenever MACD line is greater than the 9 day EMA a trader should look at buying opportunities .
The view point is bearish when the MACD line crosses below the 9 day EMA. whenever MACD line is lesser than the 9 day EMA a trader should look at selling opportunities .
MACD crossing above (signal line) is considered bullish, while crossing below zero is bearish.
Whereas when MACD line turns upwards from the central line (zero) it is considered bullish.
When MACD line turns down from central line(zero) it is considered bearish.
This unique composition of trend and momentum can be applied to Hourly, daily, weekly or monthly charts.
How MACD Histogram Strategy Works In Stock Market?
MACD is often displayed with a histogram, which graphs the distance between the MACD line and its signal line. If the MACD line is above the signal line, the histogram will be above the central line.
Whereas, if the MACD line is below its signal line, the histogram will be below the central line. Traders often uses the MACD’s histogram to identify when bullish or bearish momentum is high.
Histogram is a graphical representation of the divergence and convergence of the MACD line and the signal line. As mentioned above, histogram is calculated based on the differences between the two lines.
(Note that the histogram bars have nothing to do with the trading volume of the stock or index).
Many traders and investors uses the MACD’s histogram the same way they may use the MACD itself. Some experience is required before deciding which is best in any given situation as there are timing differences between signals you get through MACD and its histogram.
Here’s how histogram works, look at the chart below:
One should wait for the price to come either near support or resistance, before taking the trade. Reason being, the chances of reversal happening is more near SR levels, moreover MACD alone sometime gives false signals, as you can see in the chart when the MACD is below the central line but macd is above the signal line.
Generally, major breakouts usually occur when there’s low volatility in the market in other words you’ll notice the range of the candles gets small like doji’s or spinning top.
The MACD Histogram looks almost horizontally flat, usually for a minimum of 6 to 7 candles or more, without any visible peak or trough.
You can make an entry, but check if the crossover is completed between the macd and signal line. Remember the longer it remains flat, the likelihood of a stronger breakout is more.
A point of caution for newbie traders or investors to first experience the MACD alone and try to gauge the market movements rather than using the histogram, with time you will realize automatically when to use it for better trades.
What Are MACD Indicator Limitations?
The MACD indicator is considered to work best in trending markets. This limits its use for traders depending on their trading strategies. For example, range bound/consolidating markets or sideways trend, will generally give flawed signals when using the MACD.
Newbie traders may find this indicator difficult to use initially, which is why going through basic moving average and EMA and SMA fundamentals will benefit traders who are looking to make use of the MACD indicator.
As a trader you will need to follow a basic outline when using the MACD indicator:
- Selecting best EMA parameters, 12,26,9 or for faster signal you can use less interval like 5,26,5 or any other its up t you.
- Using an appropriate time frame, as MACD may function differently across time frames
The MACD serves as an oscillator as well as MACD crossover indicator. Therefore it is very useful, however it depends who is using it and how?
In the end I want you to use MACD indicator, however try to use this in combination with support resistance tools, learn about the moving averages and different candlestick patterns to be on the upper hand than your peers.
More importantly instead of trading directly first observe for couple of session whether they are working according to you.
What i mean is to do paper trading instead of live trading with your cash. Check if you were in real time trade would this has been possible and try to implement and make strategies accordingly.
Please, understand there is no 100% sure method which will make your trade every time successful, i know some people may give you guarantee to have 100% success but its next to impossible.
So, better learn it through experiencing it and I hope you will definitely going to succeed.
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