What is MACD?
MACD stands for moving average convergence divergence. It is a trend-following momentum indicator and is a lot different from the other momentum indicators.
Unlike RSI and Stochastic, MACD is a trend-following indicator used to trade trending market and it does not have overbought and oversold levels. It is shown as two lines moving without boundaries and moves freely above and below the baseline. Generally, a MACD indicator consists of a MACD line, a signal line, a baseline, and a histogram.
How is MACD calculated?
The calculation of MACD may vary as different trading platforms may have different settings and all the other indicators, the settings of this indicator can be customised too. But considering the default setting, the MACD line is calculated by subtracting the 26-period exponential moving average from the 12-period exponential moving average.
MACD LINE = 12 PERIOD EMA - 26 PERIOD EMA
And the result is shown in the form of a smooth line. As this line shows a relationship between two EMA's and not the price, and as a single EMA is not reliable, another line is plotted with the MACD line. This line is the EMA of the MACD line and is called a signal line. As the name suggests this line is used to spot buy and sell signals. And the signal line is generally a 9 period EMA.
The mechanisms of MACD
In the MACD indicator, the MACD line and the signal line are plotted over the baseline which is at level 0. And also, a histogram is drawn over this baseline.
In the above image, the blue line is the MACD line, and the orange line indicates the signal line. And these two lines are plotted over a baseline.
What does the MACD tell us?
There are various ways to look at the MACD indicator and we can consider different tools to get a signal from it.
1. MACD crossing above the baseline or zero gives us a bullish signal and when it moves below zero it gives us a bearish signal
Also, when MACD turns up from below zero it is considered bullish. When it turns down from above zero it is considered bearish.
2. When the MACD line crosses the signal line from below to above, the indicator is considered bullish
But remember the lines should be below the zero lines for a stronger signal.
And, when the MACD line crosses from above to below the signal line, the indicator is considered bearish. This time both the lines should be further above the zero lines for a stronger signal.
3. This histogram over here gives a signal of confirmed momentum change.
When green bars are formed above the baseline it tells that buyers have entered the market. And when the red bars are formed below the baseline it tells that the momentum is with sellers or sellers have entered the market.
Which MACD settings should you use?
Now just like other indicators, you can also change the settings of this indicator. You can change the inputs as per your need and also change the colours of lines and histograms.
But the question is, which settings provide the best results?
When it comes to indicators there is nothing like perfect settings or 1 single setting doesn't work with every form of trading. Like, you will need different settings for trading on a lower timeframe and different settings for trading on a higher timeframe.
If you lower the period of the slow and fast EMA, the indicator will get more sensitive to the price and give you fast and more signals. And due to this MACD works best with a lower period if you use it for scalping. But by doing that it will give you more false signals.
In the below image we have added two MACD indicators with different settings. One with a lower period and one with a higher period with a default setting.
Now, if you compare both to the price, the MACD with a lower period has given us an early signal by crossover. If you see here the MACD lines crossed the signal line and the price moved up. But while the MACD with a lower period already gave us the signal, the MACD with a higher period is lagging behind.
So, using a MACD with a lower period can be very beneficial for scalping but then you should be aware that it also gives a lot of fake signals. It is best to use MACD with a lower period if you are into scalping, but you need to gradually increase the period of EMA as you move on to day trading and swing trading.
How to add MACD to TradingView?
To add MACD to your trading view chart,
1. Click on the indicators and strategies button on the top
2. Search for MACD indicator
3. Now, click on settings, adjust the setting as per your needs and you are done
How to add MACD to MetaTrader?
To add MACD to your MetaTrader platform,
1. Go to insert option
2. Click on indicators, go to oscillators, and choose MACD
3. A box will pop up, adjust the settings as per your needs, and click on okay
4 Most common MACD strategies
Many traders use this indicator differently, they all consider different factors, let's see how traders use this indicator. There are 4 most common ways by which traders use this indicator.
1. Identification of trend based on the crossover of the baseline and the MACD line
When the MACD lines move above the baseline traders see it as a bullish trend. And when the MACD lines move below the baseline traders view it as a bearish trend. Traders believe that the baseline to be the line that differentiates between the dominance of buyers and sellers.
When the MACD line moves or is above the Baseline, it suggests that the dominance of buyers is more than that of the sellers. And when the MACD line moves or is below the baseline, it suggests that the dominance of sellers is more than that of the buyers.
Like in the above image you can see, when the market was up trending the MACD line was continuously above the baseline, indicating buyer's dominance in the market.
In this image when the market was down-trending, the MACD line moved below the baseline and it stayed continuously below the trend-line until the trend changed.
2. The MACD line and signal line crossover signal
When both the lines, that is the MACD line and the signal line is far below the baseline and when the MACD line crosses the signal line and moves above it, traders take it as a buy signal and enters a buy trade.
Like you can see in the above image, when the MACD line crossed the signal line and moved above it, the price started moving up.
In the same way, when both the lines, that is the MACD line and the signal line is far above the baseline and when the MACD line crosses the signal line and moves below it, traders take it as a sell signal and enters a sell trade.
Like in this example,
Here the macd line crossed the signal line and moved below it, and at the same time price started moving down.
3. MACD line and the signal line crossover plus the histogram
Many traders use a histogram with the above method to confirm the buy and sell signal.
Like, in the above image, when both the lines, that is the MACD line and the signal line is far below the baseline and when the MACD line crosses the signal line and moves above it, traders look for the histogram to move above the baseline and form green bars and then consider it as a buy signal and enters a buy trade.
Like in this case, here we can see that the MACD line and signal line crossover happened and at the same time the histogram turned green, and the price started moving up. So, the traders first look for crossover and then wait for the green bar to form above the baseline and then enter the buy trade.
In the same way, when both the lines, that is the MACD line and the signal line is far above the baseline and when the MACD line crosses the signal line and moves below it, traders look for the histogram to move below the baseline and form red bars and then consider it as a sell signal and enters a sell trade.
Here we can see that the MACD line and signal line crossover happened and at the same time the histogram turned red, and the price started moving down. So, here the traders first look for crossover and then wait for the red bar to form below the baseline and then enter the sell trade.
4. MACD divergence and crossover signal
Traders use a MACD divergence to spot the reversals and crossover signals for confirming the reversal. The traders first spot divergence using the MACD line and signal line and then wait for the two lines to crossover. Now, let us try to understand how do traders trade using this technique.
As you can see in the above image, the price created a higher high, but the indicator created a lower high giving us a divergence signal. After that, the MACD line moved below the Signal line giving us a confirmation of the reversal. So, traders often spot a divergence like this and then enter the trade after the crossover happens. As you can see after the divergence and crossover the price started to move down and hence gave a perfect reversal.
These are the most common ways by which traders trade using this indicator. Again this indicator works pretty well but lags. That is it gives us late signals. And just like other indicators, this indicator should not be used alone, it should be combined with other indicators or technical tools.