In order to understand; What is MACD in stocks and MACD trading strategy first, you need to know a little bit about how stocks and momentum work. Stocks are shares of ownership in a company. For example, if you own 100 shares of XYZ Company stock and it goes up/down 10 points, then your investment will be worth $10 more/less than when you bought it. The stock price fluctuates over time, this is known as momentum; it might be up or down. In other words, bullish or bearish.
What is MACD in stocks?
The MACD is a technical indicator that measures the difference between bullish and bearish momentum. It helps to identify overbought and oversold conditions and trends in stocks, commodities, currencies, and other securities.
In other words, the MACD (Moving Average Convergence Divergence) is a technical analysis tool that shows the relationship between two moving averages of prices. It can be used to identify bullish or bearish trends in the market, and it’s one of the most popular indicators among traders.
The following article will discuss how to read the MACD on your stock charts so you can make more informed investment decisions moving forward!
MACD indicator explanation
Moving Average Convergence Divergence is known as MACD. The main idea behind the MACD is to identify momentum shifts in a stock’s price.
The MACD line tracks the difference between two exponential moving averages, typically 12-day and 26-day EMAs. When prices are rising, this difference will go up; this difference will go down when prices are falling. A 9-day EMA of this difference called “the signal line” helps to determine whether there’s an overall bullish or bearish trend on a stock chart by crossing up or down through the macd line. When MACD line crosses up, there’s a bullish trend. When it falls below the signal line, there is bearish momentum on that stock chart.
How to read MACD on a trading chart?
The MACD is an indicator used for identifying trends and reversals. The 12, 26, 9 formula stood the test of time and has been widely adopted due to its effectiveness at predicting stock price movements.
The components that make up the MACD are:
The MACD is an oscillator that fluctuates above and below the zero lines. The difference between the fast EMA (12) and EMA (26) is plotted as a histogram representing the speed/direction of price movement over time. The Histograms are then used to generate trading signals or buy/sell alerts. If the histograms are above the zero line, then it’s a buy signal. If the histograms fall below the zero line, then it’s a sell signal.
Wait, We are not finished yet; there are a lot more to go.
How to calculate MACD
The first step is to obtain the MACD (Moving Average Convergence Divergence) indicator values. For that, we need two-time series. They can be obtained from opening price candles or previous closing candles – it’s up to you which one you will choose. Then, to start the calculation, find the Exponential Moving Average (EMA) for 12 and 9 time series periods of your data.
MACD Line Calculation
After calculating 12 EMA and 26 EMA, use a simple subtraction of 26EMA from 12 EMA to calculate the MACD line. So, it should be:
MACD Line = EMA (12) – EMA (26)
MACD Signal Line Calculation
In order to get the signal line, use 9-period EMA on the MACD value You got earlier. In other words, use the same value for EMA but change the period to 9. From this line, you will get your Signal Line.
Signal Line = 9 period EMA of the MACD Line
MACD Histogram Calculation
For MACD histogram calculation, You need a little easier Formula.
MACD Histogram = MACD – Signal Line
If it shows a positive value, then it will fall above the zero line. If the negative value comes, it will fall below the zero line. As we know from above, Histograms are used to generate trading signals or buy/sell alerts.
How to spot an upcoming change in trend with the MACD
As I mentioned earlier, It shows the relationship between two moving averages, one short-term and one long-term. The signal line of the MACD is simply the EMA of difference between those moving averages, which oscillates above/below zero for both bullish/bearish signals.
The first strategy to spot an upcoming trend for selling on a bearish signal; When the signal line crosses over the MACD line from below.
The second strategy is to spot an upcoming trend for buying on a bullish signal; When the MACD line crosses over the signal line from below.
If it sounds complicated to you then remember this simple rule, If the MACD line goes above the Signal line then it’s a buy signal. And if the MACD line goes below the signal line then it’s a sell signal.
Possible outcome 1: When price makes a new low, but after that, it starts to make higher highs and higher lows. In this case, we can get ready to buy.
Possible outcome 2: When price makes a new high, but after that, it starts to make lower highs and lower lows. In this case, we can get ready to sell.
Using the MACD Histogram for both entry and exit
You can also use the Histogram to generate trading signals or buy/sell alerts. But divergence trading is the best way to use MACD. Now Let’s focus on the histogram position-
1) When the Histogram is above the Zero line it’s a buy signal.
2) When the Histogram falls below the Zero line it’s a sell signal.
If you want to make sure that you are getting stronger buy signals, wait till the Histogram goes above the 0 line before taking a signal. The more you move toward the right side of the chart, the stronger your signals will be. In other words, if you are taking buy or sell signals to enter/exit a market, look for it from left to right.
It is best practice to use trading indicators with other trading tools, such as Fibonacci retracement and pivot points.
– MACD and the pivot lines (support and resistance) should provide a cross near/below significant areas or trend line breakouts.
– You can use Fibonacci retracement and the pivot lines as targets for both entry and exit signals.
-MACD can be used as a stand-alone trading tool, but if you want to increase your success rates, use it with other tools. For example, you can also use Fibonacci levels or Price Action patterns (candlestick patterns).
It is up to you where you will get your data. Usually, it is necessary to follow data from a financial website. When using 3rd party stuff, always remember that You should never go against technical analysis rules.
How to use the Moving Average Convergence Divergence as a trading strategy
Now we can dive into the MACD divergence and trading strategy. Try to avoid choosing every price pick or bottom for divergence. Instead, choose the moment when the price is going higher or lower; in other words, spot the swing high or swing low while trending. However, you can use divergences at any time of trend direction changes, but it will be easier to spot them in trending markets rather than in sideway trends (range-bound).
How to spot MACD bullish divergence
Divergence can be used during an up-trend or a downtrend, but the best results come when you use it with clear trends that show impulse moves (higher highs and higher lows).
Here are some rules for MACD bullish divergence trading strategy:
– MACD histogram is going up, but the price is going down
– The price makes a new low while the MACD line is making a higher bottom
– The MACD line crosses the signal line from the bottom up
MACD trading strategy with bullish divergences is one of the most profitable stock trading strategies. Divergence means that two indicators are telling different stories, so it’s time to act with care and use it after confirmation. One indicator gives no clear message that something is wrong, while two indicators can tell you perfectly to get ready for the next move.
When divergence happens on the MACD line, it’s a perfect signal to get ready for the next move up. When you have divergence on the MACD histogram, it’s still a good sign of trend change and it becomes more reliable while divergence matches with the line cross-overs.
How to spot MACD bearish divergence
Here are some rules for MACD bearish divergence trading strategy:
– MACD histogram is going down, but the price is going up
– The price makes a new high while the MACD line is making a lower top
– The signal line crosses the MACD line and goes down
MACD trading strategy with bearish divergence can be used in downtrends. When you see the MACD histogram inverting after the price is making higher highs, it’s a good sign that the trend will change soon. However, if you get bearish divergence on both – histogram and line – then it’s time to act with extra care because this kind of divergence means more than just a trend change – it means the reversal.
Bearish divergence on the MACD histogram is one of the best ways to trade bearish reversals. Make sure the market is coming closer to an important support level but it hasn’t broken below it yet.
Once it breaks the support, it will definitely go beyond the previous low. So when you see bearish divergence, it’s time to short the market because this kind of divergence is a sign of coming support break down which means more downside for price.
MACD Special Trading Tips
- MACD trading strategy with bearish divergence can be used in downtrends. When you see the MACD histogram inverting after the price, if you are using Bollinger Bands as one of your trading tools, don’t forget to use Moving Average Convergence divergence.
- After Breaking, support or resistance, wait for the confirmation by a retest of that support/Resistance, then entre.
- Always spot candle chart patterns like ascending triangle, descending triangle, cup and handle, bull Flag, bear flag, diamond pattern, etc.
Why it’s important not to trade on your emotions or intuition when using this MACD strategy
When using this strategy, always remember that you shouldn’t trade too much on your emotions or intuition because the markets are unpredictable. If you get really scared about missing out, then chances are high that you will overtrade and end up losing money.
Keep in mind that this strategy might not work every time so if it doesn’t work, then don’t get too frustrated. You can always try it again next time and see if you have better luck this time around. In most cases, once you find a trend change with MACD divergence, you will make money for sure.
Be strict to the Strategy:
– Create a chart with both – MACD histogram and price candlesticks
– Once you see the histogram is going down, while the price is making a new high – it’s a good time to sell after a trend line breakout.
– The same applies to downtrends: once you see the MACD line going up while the price makes a lower bottom. In this case, it’s time to buy after a trend line breakout.
– Wait for the price to retest the support/resistance where you see candle pattern reversal.
– Enter trade with confirmation from candlestick pattern breakout. Keep in mind that false breakout might lead to poor results so be careful when using this MACD strategy. Using Bollinger bands instead of standard deviation is better if you are not yet sure what you are doing.
In conclusion, bearish divergence on the MACD histogram is a reliable way of spotting trend changes and support/resistance breaks. It’s better to trade with confirmation from other trading signals because false breakouts can lead to losing money instead of making it. At the same time, you should only use this strategy when you see a clear and stronger pattern of candle formation. If the signals look weak then it’s better not to use this strategy at all.
Limitations of MACD
Here you should pay close attention because the MACD oscillator works well in most cases, but there are situations when it’s better to not use it.
The very first thing that I would like to tell you about MACD is that it is not a holy grail for trading. It’s just a momentum oscillator and as such, there is no way for it to be able to predict changes 100% in price trend.
In addition, the indicator has a certain inherent lag. This happens because it is built from moving averages, which are lagging indicators by definition.
In most cases, the indicator will help you to find emerging trends before they take off and confirm them when they start to materialize. However, there are also some circumstances where the MACD oscillator gives false signals that can rip-
– False breakouts can lead to losing money.
– Histogram has a delay sometimes, so you have to wait until the line gets confirmation from price action.
– You should know that the indicator cannot be useful in all markets and for all currency pairs. For example, it will not work well in a ranging market, while trends are easy to spot on lower timeframes like H1 or M30.
– Sometimes you need to add other confirmation tools such as RSI to avoid false breakouts.
– Don’t use the MACD in overbought/oversold when it’s too late to sell or buy.
Final Thought on Moving Average Convergence Divergence (MACD)
The MACD is a momentum indicator that measures the difference between two exponential moving averages of prices. It can be used to identify changing trends in stocks and to generate trading signals. When you see an uptrend, it means time is on your side so you should buy more shares. If there’s a downtrend or price fluctuation, then now may be the best time to take profits by selling some stock before things get worse.
The MACD technical indicator is very useful not only because it identifies the direction of price movements, but also because it can track trends and momentum. For instance, if the MACD moves higher while the price moves lower, that means the downside momentum is weak, and the upcoming trend is bullish.
Finally, what is MACD in stocks, and what should be your trading strategy – here are the keynotes:
- The MACD is a technical indicator that calculates the difference in price between two Ema’s.
- It’s used to predict changes in stocks prices, as well as to identify trends or even oversold stocks.
- The MACD consists of two lines on a chart; the MACD Line plots the difference between an index like stocks or commodities over time.
- The Signal Line moves above or below it according to whether there are more buyers or sellers at any given point in time.
- A nine-day exponential moving average (EMA) is applied to both line differences, which smooths out short-term fluctuations and makes them easier to read.
- When the MACD Line crosses over the Signal Line from below, this indicates that momentum has shifted towards buying pressure.