What is the MACD Indicator?

The MACD indicator is one of the most famous trading indicators. It was invented in 1979 by Gerald Appel. Gerald Appel was a seasoned financial analyst and fund manager. His experience in trading and analysis triggered the creation of the MACD indicator.

To date, traders utilize the MACD indicator to predict the rise and fall of prices of crypto assets and other financial instruments. You may consider adding this indicator to your technical analysis arsenal if you are a crypto trader. This article will explain how the indicator measures price, predicts trends, and how the indicator can be used effectively. But first, what exactly is the MACD indicator?

The MACD Indicator

MACD stands for Moving Average Convergence and Divergence. It is a technical analysis tool that indicates the price’s direction and makes it easier for traders to predict trends. It can also provide more specific details on entry points for buy and sell trades.

With the MACD, traders can measure much more than the price’s direction. The MACD oscillator can also measure a trend’s strength, momentum, and longevity. The MACD uses Exponential Moving Averages to display the price’s average movement over a specific period.

To fully understand the MACD indicator, you must first understand all its components and what they represent.

Components of the MACD Indicator

The MACD indicator is made up of these components:

• The MACD line is the difference between a 26-period exponential moving average (EMA) and a 12-period EMA. The 26-period EMA is the slow-moving average, while the 12-period EMA is the fast-moving average.
• The signal line is a 9-period EMA of the MACD line and is used as a trigger for buy and sell signals. Note that the period could vary depending on the timeframe of the chart. On a chart with the daily timeframe, the signal line will be the 9-day EMA, while an hourly chart will have the 9-hour EMA as its signal line.
• The MACD histogram is the difference between the MACD line and the signal line. The histogram is used to identify bullish or bearish divergences between the two indicators.
• The zero line is the point at which the MACD line equals zero. This point is often marked on a MACD chart with a horizontal line at the level of zero. The zero line is a reference point to help identify bullish or bearish signals in the MACD.

Image source: TradingView

The image below shows the chart’s MACD line, signal line, histogram, and zero line. The zero line is the line that separates the negative portion of the histogram from the positive portion. The red and green portions of the chart are the histogram. The blue line represents the MACD line, while the red line represents the signal line.

The MACD Formula

The formula for calculating the MACD indicator is as follows:

MACD = 12-day EMA - 26-day EMA

Signal Line = 9-day EMA of MACD

The histogram value is derived from the difference between the MACD and the Signal Line.

MACD Histogram = (12-day EMA – 26-day EMA) – (9-day EMA).

How to Trade with the MACD Indicator

The MACD indicator is quite easy to read and interpret. It shows bullish and bearish signals and can be very effective in a trending market.

Image Source: TradingView

Notice how Bitcoin’s price reacts at various points in the chart above. The most significant price movement was from the $16.3K region to the $16.9K region. The price of Bitcoin pumps at that level. Note how the price appreciation gradually ends around the $16.9 level after the MACD line crosses below the signal line.

Finally, observe how the MACD indicator fails to provide absolutely clear signals when the market ranges between the 18th and 19th of January. By implementing the Crossover trading technique, traders could open and close buy positions when needed. Aside from Crossover trading, the MACD indicator can also be traded using divergence and Overbought or Oversold signals. But first, how do we trade using the Crossover technique?

Crossover Trading

Traders look for a crossover between the MACD and the signal line. If the MACD line crosses above the signal line, it indicates that a significant rise in the crypto asset’s price may be coming. It’s a bullish signal.

Similarly, if the MACD line crosses below the signal line, the crypto asset will likely depreciate. The cross below the signal line is a bearish signal.

From the BTC/USDT chart above, the crossover occurs when Bitcoin trades around $16.4K. Following the crossover, Bitcoin’s price increases significantly.

Eventually, the bullish momentum slows down, and the MACD line crosses below the signal line. Although a massive price dump is absent in this instance, the bearish crossover revealed a decline in bullish activities.

Divergence Trading

You can also trade with the MACD by looking for divergences between the MACD line and the cryptocurrency’s price. A bullish divergence occurs when the crypto asset makes new lows, but the MACD line is not confirming these lows.

When a crypto’s price trends downwards and the MACD line does not reflect this decline, it could mean the bearish trend is weakening. Similarly, the crypto asset could form new highs, but the MACD line may not conform to these highs. When the MACD fails to align with the new highs formed, it indicates that the bullish momentum is weakening. Thus, traders expect a reversal or bearish divergence at this point.

Overbought and Oversold

Traders also use the MACD indicator to identify overbought and oversold cryptocurrencies. When the MACD line is above the signal line and the histogram is positive and increasing, it means the crypto asset is overbought. At this point, traders anticipate a price correction.

On the other hand, when the MACD line is below the signal line, and the histogram is negative and decreasing, it could mean the crypto asset is oversold. Thus, traders expect a bullish price reversal.

Image Source: TradingView

Benefits of the MACD Indicator

The MACD indicator has the following benefits:

• Identifying Trend Direction: The MACD indicator identifies a trend’s direction. The crossover of the MACD line and the signal line can provide early signals of a potential trend change, allowing traders to enter or exit positions at an early stage.

• Measuring Momentum: The histogram can be used to measure momentum. When the histogram is positive and increasing, it indicates that the MACD line is moving further away from the signal line.

  When the MACD line trends higher, it represents an increased momentum and further diverging of the two MAs. On the flip side, a falling MACD line indicates bearish momentum and the converging of the 12-period EMA and the 26-period EMA.

• Identifying Overbought and Oversold Conditions: The MACD can identify overbought and oversold conditions in the market.

• Confirming Other Indicator Signals: The MACD can confirm signals generated by other indicators. For example, a bullish crossover of the MACD line and the signal line can confirm a bullish signal generated by a moving average crossover.
• Easy to interpret: The MACD is relatively easy to interpret, even for traders with little technical analysis experience. The histogram, the signal line, and the MACD line are all coherent and comprehendible.

Limitations of the MACD Indicator

The MACD indicator has the following limitations:

• The Indicator Lags: The MACD is a lagging indicator. It is based on past price movements and can provide signals after a trend has already begun. This can result in traders entering a trade too late and missing out on potential profits.
• False Signals: The MACD can also generate false signals, especially in choppy markets. Thus, traders can incur losses if they rely solely on the MACD indicator.
• Limited Use: The MACD primarily identifies trends and momentum in the market, and it may be less effective in other market conditions, such as sideways or range-bound markets.
• Need for Confirmation: The signals from the MACD need confirmation before being used. Traders need to use the indicator harmoniously with other technical indicators like RSI, trade volume, and so forth.

MACD Strategies in Crypto

For improved accuracy, the MACD can be traded with other technical indicators. There are various strategies for using the MACD, along with other indicators. The Relative Strength Index, the Volume, and the Bollinger Bands are some of the most common indicators used with the MACD.

Using MACD with RSI

When using the MACD with the RSI, note that the two indicators may sometimes conflict. This is because they do not measure the same thing. The MACD measures the relationship between two exponential moving averages, while the RSI measures price alteration based on recent demand and support zones.

To improve the analysis probability, traders open buy positions when the MACD line crosses above the signal line, and the RSI is below the 30 mark. When the RSI is below 30, it indicates that the market is oversold, and buyers may take over soon. When this bullish signal occurs around the same time the MACD line crosses above the signal line, traders are more certain of a bullish rebound.

Similarly, when the MACD line crosses below the signal line, and the RSI value is above 70, this strengthens the possibility of a bearish reversal.

Using the MACD with Volume

The Volume indicator is one of the easiest indicators to interpret, but it should always be used along with another technical indicator. When used with the MACD, it improves traders’ conviction on trend reversals. The height of the volume bars on the chart gives traders an insight into the market activity.

Volume is best used with the MACD crossover strategy. When the MACD line crosses the signal line and the volume on the chart soars, this indicates that more traders are in the market. An increase in trade volume at significant levels or crossovers increases the chances of price reversal. Also, a decline in volume after a trade has been executed using the MACD crossover can prompt traders to take profits.

Using MACD with Bollinger Bands

Combining the MACD indicator with Bollinger Bands can help traders track trend momentum and volatility. The MACD measures momentum, while Bollinger Bands measure volatility. Traders lookout for potential divergences in the MACD histogram, which could be the start of a trend reversal.

The trend reversal is matched with the Bollinger Band signals. If the price begins to break out of the bands following the MACD divergence, it strengthens the basis of a trend reversal. Further, if the bands keep expanding, it shows increased volatility. This also gives a solid basis for opening reversal trades.

In summary, expanding Bollinger bands indicates a rise in volatility, and a price breach of the bands could signal a potential breakout. These signals can be used in sync with the MACD. When the MACD indicator diverges from price and the histogram bars get longer, it shows increased momentum. Combining the signals from both indicators provides a stronger basis for confirming trend reversals and opening long or short positions.

Conclusion

The MACD indicator is an effective trading indicator in trending markets. It can be used to spot potential price reversal zones, and trend continuation. However, the indicator may be less effective when a cryptocurrency’s price ranges.

Implementing proper risk management strategies is vital when using the MACD indicator. Also, combining the information from the indicator with other technical analysis tools and even fundamental analysis will yield the best results for traders.