05 Jun 2020 | AtoZ Markets - MACD indicator mostly use to identify the new trend and also help to identify the end of the current trend. There are many ways to measure the signals produced by MACD. Many traders use their own settings and methods, which suits their trading psychology and trading style.
What Is the MACD?
A trend-following momentum indicator that reflects the connection between two moving averages of a security's price is known as MACD (Moving Average Convergence Divergence). It is calculated by deducting the 26-period EMA (Exponential Moving Average) from 12-period EMA, and the outcome of this calculation is the MACD line.
A 9-period EMA of the MACD is called the 'signal line', which is plotted on top of the MACD line. 'Signal line' indicates the signal for buy and sell. When the MACD line crosses upwards from its signal line, traders can buy the security and sell when MACD crosses below the signal line.
Various methods out there to interpret Moving Average Convergence Divergence (MACD), among them the most conventional tactics are Crossovers, Divergence, and impulsive ups and downs.
How MACD Indicator Works?
The MACD indicator uses two moving averages and a histogram to work. The two lines inside the indicators are actually exponential moving average (EMA) but may seem like a simple moving average (SMA). Usually, the MACD line is the slower line and the faster line is the signal line.
When the two moving averages take place together, they are called Convergence. If the lines split away from one another they are called Divergence. Histogram illustrates the difference between the two lines. Moreover, while trading upon the zero lines the indicator would confirm a bullish trend and below the zero lines, MACD used to confirm a bearish trend.
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Furthermore, when the market is trending upward and making higher highs and higher lows. While breaking the key resistance levels, a trader might enter a buy position. In contrast, when the market trending downward and making lower highs and lower lows, a trader might enter a Sell position.
Basic Formula of MACD
MACD = 12-Period EMA - 26-Period EMA
MACD calculates by deducting the long-term EMA (26-days) from the short-term EMA (12-days). EMA is a kind of moving average (MA) that holds a wide and loud meaning over the maximum number of current data points. A simple moving average (SMA) also refers to a massive impact on current price shifts as same as EMA.
However, an exponentially moving average (EMA) responds more effectively to the current price shifts than a simple moving average (SMA).
3 Most Popular MACD Trading Strategies
There are a huge amount of MACD trading strategies, which is used by professional traders to find opportunities in the markets. Three of the most popular MACD trading strategies cover:
- Crossover
- Histogram Reversals
- Zero crosses
MACD Crossover Trading Strategy
MACD crossover strategy concept is as same as the Stochastic Oscillator trading method. Both provide buy and sell signals with the crossover between the two lines. Like many other crossover strategies, a buy signal comes when the MACD line crosses above the lower line.
In contrast, sell signals come when the MACD line crosses below the signal line. Before opening a position, a crossover strategy waits for a movement to happen because of its retreating nature.
That means crossover strategy works a little slower. In a volatile market trend when MACD provides a signal, the price may reach the reversal point. It can be considered as a false signal.
The image above highlights the standard crossover strategy. It showing the false buy signal as well as the profitable sell signal.
MACD Histogram Reversal Trading Strategy
The most useful part of the MACD is the histogram. The histogram bars illustrate the imparity between the MACD line and the Signal line. When the histogram increases in height that means the market price is moving impulsively in a direction.
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In contrast, when the histogram compresses, that means the market is moving slowly. Therefore, when the histogram moves further away from zero, the moving average lines are moving further separately. When this process is over, the hunched shape will possibly arise. This is the earlier sign of moving averages is tightening again. This is also an oncoming sign of crossover.
The chart above showing the potential to utilize the histogram as a trading tool. By using the histogram tool for trend riding, the chart above shows four profitable trades. You can also use this tool to place a take a profit.
MACD Histogram Zero Crosses Trading Strategy
The zero crosses strategy is very simple. It's based on either of the MACD crossing the zero line. When the MACD line crosses the zero line from downside, it signals that uptrend may be forming. In contrast, when the MACD line crosses the zero line from upside, it signals the downtrend may be emerging.
This type of market signals happens very often, so you will typically find fewer of them. Most of the time it's gives a false signal also.
The strategy is when the MACD line crosses above the zero line, you can enter a buy or close a sell position. Alternatively, when the MACD line crosses below the zero line, you can enter a sell or close a buy position. In the impulsive or volatile market, you can find the signal after the movement has already happened. So, you need to be very careful with this trading method.
The chart above showing the two buy signal, which had become profitable when the trader can maintain a well-planned entry and exit point. This was the recent market scenario of NZUUSD. When you use the zero-cross strategy you have to understand first, where to exit the market, or place a Stop loss.
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Summary
If we summary the total process it would be like this-
- MACD is the most common indicator, which used by many professional traders for technical analysis.
- MACD works using the three elements: two moving average and histogram.
- Convergence happens when the two moving averages come together and for divergence, they have to move away from each other.
- The most common strategies of MACD: crossover, histogram reversal, and zero crosses.
- It can be applied on any timeframe based on individuals trading plan.
It's good to maintain the money management system that suits your trading psychology. Moreover, always maintain the 1:2 risk-reward ratio.
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