Moving Average Convergence Divergence (MACD) is a momentum indicator used by traders to determine if the short-term trend is working in their favor.
MACD crossovers are used to signal to buy and sell opportunities.
A quick introduction
Last week we saw that moving averages are great to identify (detect) trends in the market because they represent bullish momentum if the smooth line is slanted upward. Well, MACD is a momentum indicator with its own set of advantages and one disadvantage. Traders can get a clear picture of short-term trend and market sentiment when analyzing the MACD because it represents the relationship between two exponential moving averages (exponential moving averages are a type of moving averages that weigh more recent price data).
MACD = EMA12 — EMA26 Signal line = EMA9(MACD)
What does it tell us?
For starters, the advantage of taking the difference of a shorter and faster exponential moving average (EMA12 and EMA26 respectively) is that we can easily identify the short-term trend of the market and the intensity of momentum at a specific period. Thus, if the MACD rises it means that recent price data is increasing at a faster rate than prior data points (buying pressure/momentum).
The general layout of the MACD is plotting the signal or basis line on top of the former. This is extremely useful because the exponential moving average of the indicator- the signal line- reflects the overall trend of the market. Traders often use crossovers between the MACD and the signal line as buy and sell signals. But we must add further interpretation to the analysis because the flaw of the MACD is that it produces false positives or breakouts; so, keep an eye on the spread between the MACD and the signal line, plotted with histograms, as it suggests momentum and if bitcoin is overbought or oversold, for example.
How to use it in a simple strategy
The first step in the analysis and interpretation process is to identify the overall long-term trend. Once we have the long-term trend- bullish in the case of bitcoin- it’s time to see if the MACD confirms our initial hypothesis.
If: Signal line is slanted upward -> Bullish Trend
If: Signal line is slanted downward -> Bearish Trend
To do that, we need to look for two confirmations or buy signals. Start by interpreting the histogram. Is it above or below 0? If it’s above zero (bullish) how large are the bars? If the bars are increasing it means that bitcoin is being bought up and if the spread continues to become greater, bitcoin may become overbought. On the contrary, if the bars begin to decrease it means that the price is going to retrace back to the average, so it’s best to wait to see what happens once both lines converge.
BUY if -> signal line slanted upward + positive histogram bars + MACD crosses above or bounces off the signal line
SELL if -> signal line is slanted downward + negative histogram bars + MACD crosses below the signal line
The Moving Average Convergence Divergence is one of the most popular momentum indicators because it is easy to interpret and apply to trading strategies. By plotting the difference between two exponential moving averages we can detect short-term trends and infer if momentum is picking up or shifting. It’s important to note that the MACD produces a variety of false positives, so it’s recommended to add different indicators to your analysis for correct signals. Trade safe.