MACD Indicator Explanation

Moving Average Convergence Divergence (MACD) is an oscillating indicator widely used by traders in technical analysis (TA). MACD is a trend-following tool that utilizes moving averages to determine the trend of stocks, cryptocurrencies, or other tradable assets.

Developed by Gerald Appel in the late 1970s, the MACD records past price movements and thus belongs to the lagging category of indicators (providing trading signals based on past price behavior or data). MACD can be used to measure market trends and potential price directions, and many traders use it to identify potential buy and sell opportunities.

Before delving into the MACD mechanism, it is important to understand the concept of moving averages. A moving average (MA) simply represents the average of historical data over a predefined period. In the context of financial markets, moving averages are among the most popular technical analysis (TA) indicators, which can be divided into two types: Simple Moving Average (SMA) and Exponential Moving Average (EMA). SMA weights all data inputs equally, while EMA gives more weight to the most recent data points (newer prices).

How MACD Works

The MACD indicator generates its main line (MACD line) by subtracting two EMAs, then uses this to calculate another EMA, called the signal line.

Additionally, there is the MACD histogram, which is calculated based on the difference between these two lines. The histogram, along with the other two lines, fluctuates above and below the centerline, also known as the zero line.

Therefore, the MACD indicator consists of three elements moving around the zero line:

1. MACD Line (1): Helps determine upward or downward trend (market trend). It is calculated by subtracting the 26-period EMA from the 12-period EMA.

2. Signal Line (2): The 9-period EMA of the MACD line. Analyzing the combination of the MACD line and the signal line helps identify potential reversals or entry and exit points.

3. Histogram (3): Represents the divergence and convergence between the MACD line and the signal line. In other words, it is calculated based on the difference between the two lines.

MACD Line

Generally, the EMAs are calculated based on the closing prices of the asset, with typical periods set at 12 (faster) and 26 (slower). These periods can be configured in different timeframes (minutes, hours, days, weeks, months), but this article focuses on the standard daily setting. Nonetheless, the MACD can be customized according to different trading strategies.

Assuming the standard setting, the MACD line is calculated by subtracting the 26-day EMA from the 12-day EMA:

MACD Line = 12-day EMA - 26-day EMA

As described above, the MACD line oscillates above and below the zero line, signaling crossovers of the midline, indicating when the relative position of the 12-day and 26-day EMAs changes.

Signal Line

By default, the signal line is calculated as the 9-day EMA of the MACD line, providing further analysis of its previous movements.

Signal Line = 9-day EMA of MACD Line

While not always perfectly accurate, when the MACD line and the signal line cross, this event is often regarded as a trend reversal signal, especially when it occurs at the peaks (far above or below the zero line) of the MACD chart.

MACD Histogram

The histogram provides an intuitive record of the relative movement between the MACD line and the signal line. It is calculated by subtracting the signal line from the MACD line:

MACD Histogram = MACD Line - Signal Line

However, the histogram is not an additional moving line but a series of bars, making it easier to read and interpret visually. Note that the histogram bars are unrelated to the trading volume of the asset.

MACD Settings

As mentioned above, the default MACD settings are based on 12, 26, and 9 periods for the EMAs—i.e., MACD(12,26,9). However, some technical analysts and chart experts may use more sensitive period settings. For example, MACD(5,35,5) or longer periods are often used in traditional financial markets, such as weekly or monthly charts.

It is worth noting that due to the high volatility of the cryptocurrency market, increasing the sensitivity of the MACD indicator may generate more false signals and misleading information, thereby increasing risk.

How to Read MACD Charts

As the name suggests, the MACD focuses on the relationship between moving averages, which can be described as converging or diverging. When the two lines approach each other, it is called convergence; when they move apart, it is divergence.

Nevertheless, the signals related to MACD are associated with so-called crossovers, which occur when the MACD line crosses above or below the centerline (centerline crossover) or when it crosses the signal line (signal line crossover).

Remember that centerline and signal line crossovers can occur multiple times, producing many false and misleading signals—especially in volatile assets like cryptocurrencies. Therefore, relying solely on MACD signals is not advisable.

Centerline Crossover

A centerline crossover occurs when the MACD line moves above or below the centerline. When it crosses above the centerline, it indicates a positive MACD, suggesting that the 12-day EMA is greater than the 26-day EMA. Conversely, when the MACD line crosses below the centerline, it indicates a negative MACD, meaning the 26-day EMA is higher than the 12-day EMA. In other words, a positive MACD indicates strong upward momentum, while a negative MACD indicates strong downward momentum.

Signal Line Crossover

When the MACD line crosses above the signal line, traders often see it as a potential buy signal (entry point). Conversely, when the MACD line crosses below the signal line, it is generally viewed as a sell signal (exit point).

While signal line crossovers can be helpful, they are not always reliable. It is also important to consider their position on the chart to minimize risk. For example, a buy signal from a signal line crossover might still be risky if the MACD line is below the centerline (negative), indicating a bearish market condition. Similarly, a sell signal might be less reliable if the MACD line is above the centerline (positive), suggesting a bullish trend. In such cases, following the crossover signal alone could lead to greater risk (larger downward trend).

MACD and Price Divergence

In addition to centerline and signal line crossovers, divergence between the MACD and the asset’s price can also signal potential reversals.

For example, if the price of a cryptocurrency is rising but the MACD forms a lower high, this is called bearish divergence, indicating that despite the price increase, the upward momentum (buying pressure) is weakening. Bearish divergence is often interpreted as a sell signal, as it frequently precedes price reversals.

Conversely, if the MACD forms two higher lows while the asset’s price forms two lower lows, this is considered bullish divergence, suggesting that despite the price decline, buying pressure is increasing. Bullish divergence appearing before a price change may indicate a short-term bottom reversal (from a downtrend to an uptrend).

Summary

In technical analysis (TA), the MACD is one of the most useful tools. Not only because it is relatively easy to use, but also because it is very effective in identifying market trends and momentum.

However, like most technical indicators, the MACD is not always accurate and can generate many false and misleading signals, especially when analyzing assets with poor stability or markets in weakness and sideways movement. Therefore, many traders use MACD in conjunction with other indicators, such as RSI, to further reduce risk and confirm signals. **$MAGIC **$MAPO **$HUMA **