MACD 101

Written by Edward Gonzales

July 23, 2021

When it comes to analyzing data fortunately there are many tools and indicators available to us. Each indicator has a use case and was designed for a specific purpose. We have recently covered the RSI indicator in a similar article. Today we will be outlining the MACD indicator and its use case for trading cryptocurrency. Although we will be using cryptocurrency pairs in the examples provided, note that the indicator is also applicable to stock and Forex markets. 

Background

MACD stands for moving average convergence/divergence. This oscillator was created by Gerald Appel in the late 1970s to measure both trend momentum and direction. Typically the inputs for the indicator will populate automatically. When the script was formulated it was based on only the daily time frame and a six day work week. This is why the values have been measured out the way that they have. 

The technology available at the time did not allow most users to view or generate information on smaller time frames. Therefore the fast length uses a value of 12 as this would be two work weeks worth of information. The slow length uses a value of 26 which would be a work month worth of information. The fast length minus the slow length gives us our MACD line. The source dictates where the information will be calculated from. It is suggested to use candlestick closes as they are better confirmations. The signal smoothing having a value of 9 means that it uses one and a half work weeks data. It is used to determine a change in momentum when crossing over the MACD line. The Oscillator MA type and Signal line MA type inputs allow a trader to select exponential moving averages (EMA) or simple moving averages (SMA). We will not get to into style or visibility too heavily as they are more for user preference and do not affect the indicators interpretability. 

Use case

Now that we understand the value inputs for the MACD indicator lets take a look at how to read them. The MACD signal line is usually displayed in blue while the signal line is usually displayed in orange. We also have the histogram. This is also the difference of the MACD and signal line except displayed in bar format. The height of the bars show the strength of the movements. 

When the MACD shows a bearish crossover it usually signals that there will be some downward price action. In the photo below we have highlighted a crossover area. The MACD line (blue) crossing over the signal line (red) gives us a bearish crossover. When the MACD line is underneath the signal line it generally means there is an active downtrend. Note how on the histogram the bars also cross over the median. As the histogram bars grow larger, the downtrend grows deeper. As the histogram bars start shrinking and reverse direction back to the median the downtrend weakens. 

A bearish crossover occurrence is a good sign to look for a short opportunity. It is important to note the price ranges being traded when using the MACD to determine entries and exits. 

When the MACD line crosses over the signal line it is indicative of upward price action. This can also be observed in the histogram as well. If the MACD line is trending above the signal line it is indicative of upward price action. Again as the histogram stops making bigger bars and starts producing smaller bars it is indicative of a trend reversal. When a trader observes a bullish crossover it is generally a good idea to look for long position entries. (Example photo below)

Finally, when the MACD and signal lines are trending above the histogram median, the larger picture is considered an uptrend. On the flip side, when the MACD and signal lines are trending below the histogram median, the larger trend is considered a downtrend. (Example below)

Here we have pulled a smaller time frame to observe the relationship between crossovers. Trading the MACD crossovers is one of the easiest and most profitable strategies to date. Basically, when a bullish MACD crossover is observed a trader takes a long position. When the bearish crossover is observed the traders closes the long position for profits and begins looking for a short entry. After the next bullish crossover, the short position should be closed for profits to look for the next long opportunity. Not every crossover will be 100% accurate or profitable which is why it is important to use multiple time frame analysis to compare data spreads. While it is possible to rely on just one time frame it is not practical. 

It is uncertain what any asset may do regardless of the indicator being used to measure or its success rate. That is the entire dilemma of trading. We must use the tools available to us to infer what the market might do next. The MACD indicator is generally very reliable and trustworthy. It can be combined with other indicators to help infer the status of a market prior to planning a trade. You can visit our website to learn about other tools and indicators available to you as a trader.

By viewing any material or using the information within this publication you understand that this is general education material and you can not hold any person or entity responsible for loss or damages resulting from the content or general advice provided here. Trading cryptocurrency has potential rewards, but also potential risks. You must be aware of the risks and be willing to accept them in order to invest in the markets. Only trade with funds you can afford to lose. This publication is neither a solicitation nor an offer to buy/sell cryptocurrency or other financial assets. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in any material on this website. The past performance of any trading system or methodology is not necessarily indicative of future results.

Written by Edward Gonzales © Crypto University 2021

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