Investing > Complete Guide to MACD Indicators

Complete Guide to MACD Indicators

Trying to better understand those confusing candlestick charts? MACD will help you with that.

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Updated January 08, 2022

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Can you imagine driving on a highway with lots of traffic—and no designated traffic lanes?

It’s easy to imagine that chaos would quickly ensue.

Luckily, most of us have an entire system of lines that tell us where we’re supposed to go: double yellow, dotted yellow, dotted white, bike lanes, turn only lanes, etc.

Navigating the stock and forex markets can sometimes feel like trying to drive through rough terrain with no GPS, no painted lanes, and sometimes—no road at all.

But it doesn’t have to be that way: the more you learn key forex indicators, the more you can find your path through all the chaos. With the Moving Average Convergence Divergence (MACD), you even get a beautiful set of lines to help you interpret the chaos of an asset’s fluctuations. ✅

Sometimes stock and forex prices shift because of world news, like stocks rising after the news that the U.S. inflation rate reached a 13-year high in August. But sometimes fluctuations follow predictable patterns of supply and demand – and this is where indicators can really help you make strong trading decisions. In this guide, you’ll learn everything you need to know to start using MACD as easily as you use the right-turn lane. 

What you’ll learn
  • What is MACD
  • How MACD Works
  • How to Trade with MACD
  • MACD Pros and Cons
  • MACD Alternatives
  • Conclusion
  • MACD FAQs
  • Get Started with a Stock Broker

MACD Definition 📚

We know all those spooky letters can get you stressed out if you don’t know what they mean. But don’t worry: MACD is one of the most popular stock and forex indicators because it is fairly straightforward and incredibly useful. So if you’re here because all of your tech stocks suddenly took a dive and you need to find some new strategies, don’t worry: you can absolutely learn this!

MACD stands for Moving Average Convergence Divergence. Okay, that title might not make this concept that much more accessible, so let’s break it down a little farther. First things first: what is a moving average

A stock’s price changes all the time. Still, you might want to know what its average price was yesterday, or over the last month, or over the last two months. Moving averages are calculated so that you can see what a security’s price has been over a certain period of time. They’re moving because they’re constantly being updated, as the security’s price is constantly changing. 

So what about all this convergence divergence business? Well, in this indicator we set up two moving averages. Let’s say one is a 50-day moving average, and the other is a 200-day moving average. We’ll then compare these two lines in order to determine how the overall trend is going. 

MACD Definition
The 50-day simple moving average (orange) and the 200-day simple moving average (purple) can tell you the overall long-term price trend of an asset. Image by TradingView.

MACD is useful to figure out whether you should open a long or short position, and when precisely you should buy or sell. So as you’re watching the news and seeing that the Dollar is hovering near its peak or Chinese stocks are suffering due to crackdowns, you can supplement this knowledge with a comparison of the price trends over time to determine whether it’s a good time to change up your trades. 

How Does MACD Work? 🛠️

Now we’ve got the basics of what MACD is – let’s explore how this actually functions to give you a sense of what’s going on with a particular security. With more and more people turning to forex thanks to its accessibility, you definitely want some competitive advantage, even if you’re just getting started in forex.

When traders are using the MACD, they are usually trying to tell where the security is trending. When the two lines cross each other, that indicates that a price change is about to happen – and if you can predict when a security is going to cross those support and resistance lines, you stand to make a pretty penny.

MACD Components 🧩

Let’s break out a MACD chart. If you’re not already a pro at reading forex charts, you’ll want to start there and then come back to us.

MACD Components
The typical 12, 26, 9 MCAD indicator. Image by TradingView.

You’ll usually see a MACD setting expressed in three numbers. The default with most premium forex brokers is 12, 26, 9. The first number represents the number of time periods (such as hours, days, weeks, etc) used to calculate the faster average. The second number is the number of time periods used in the slower moving average. 

The third number represents how many bars are used to calculate the moving average of the difference between the other moving averages. We know what you’re thinking: now we have a moving average of moving averages?? But don’t worry – you’re not going to be the one calculating all of this.

But what about the chart itself? Here we see two lines: these are called the MACD line and the signal line. The MACD line (blue) is the difference between the slower and faster moving averages. If you’re using a 12, 26, 9 setting, then the MACD line is showing you the difference between the 12-day moving average and the 26-day moving average. (Remember, it doesn’t have to be days: it can be any time period you choose!)

The other line is the signal line (orange). Remember the moving average of the difference between the moving averages? From like two paragraphs ago? That’s what the signal line represents. Using the default 12, 26, 9, the signal line would show a 9-period moving average of the MACD line.

So why do we do all of this? The moving averages (and the moving averages of those) are a way of smoothing out minute-by-minute price fluctuations of a security. It’s a way of zooming out and seeing what the larger trends of a security are. 

How to Read MACD 📋

So now you understand how our metaphorical traffic lines are – but you don’t know yet which ones are telling you to turn right, or that it’s okay to pass, or whatever other traffic rules you want to see in this extended analogy we’ve got going here. 

Sometimes we’re going to see all four lines on the chart: the two moving averages, the MACD line, and the signal line. This sets you up with all the information you need to make more informed trading decisions.

 50-day SMA
50-day SMA (yellow) and the 200-day SMA (purple) paired with MCAD tell us how strong the upward or downward momentum of a price is. Image by TradingView.

Let’s go section by section and learn how to interpret this chart.

  1. The moving averages. If the shorter time period (faster-moving average) is higher than the longer time period (slower moving average), that means the price is trending upward. If the longer time period is higher, that means the price is trending downward. 
  2. The MACD line. The higher up the MACD line is from the baseline, the greater the distance between the two moving averages. This can help you determine the momentum of the trend: the larger the difference, the faster price movement is accelerating. 

Remember: these trends might happen for any number of reasons. It could be that the NASDAQ has taken a dive, either temporarily or long-term; or it might be that the public has lost faith in this specific company. The MACD can’t tell you everything about price changes, so be sure to supplement it with your own research. 

How to Trade with MACD 📈

There are rules of trading, and there are rules of the road (okay, we’ll stop now). Basically:

  • If the shorter time period is higher than the longer time period – enter a long position. 
  • If the longer time period is higher than the shorter time period – enter a short position.
  • Use the signal line to tell you whether a trend is speeding up or slowing down, which can help you determine when to enter or exit a trade.

MACD Crossover 💫

Sometimes the MACD line and the signal line cross each other. These are big signs that it’s time to enter or exit a trade. Here’s what a crossover looks like:

MCAD line crossing
The MCAD line crossing the signal line from below confirms that a bullish trend will continue on. Image by TradingView.

When the MACD goes below the signal line, that means the market is bearish, and you may want to sell. When the MACD goes above the signal line, that means the market is bullish, and you may want to buy as the price will likely continue to go upward. 

Some traders wait until the cross actually happens to make their trade, while others will try to anticipate crossovers. Of course, this can be risky. Crossovers are a better indicator if they agree with the larger upward or downward trend in price as indicated by the comparison of the two moving averages. 

MACD Divergence ↕️

A “divergence” is when the MACD creates highs or lows that diverge from the highs and lows of the actual price. When the MACD creates two rising lows while the security price is creating two falling lows, that is a bullish divergence. This is a better indicator when the long-term price is trending upward, though some traders try to use it during negative trends, as they can sometimes (though less frequently) indicate a switch in trend direction.

Bullish divergence example
Bullish divergence example. Image by TradingView.

Conversely, the MACD can form two falling highs corresponding with two rising highs of the price. This is a bearish divergence, and if it occurs during a longer bearish trend, that means the price will likely continue to be bearish.

Bearish divergence example
Bearish divergence example. Image by TradingView.

MACD Rapid Fluctuations 💨

The MACD is meant to smooth out the frequent price changes of a given security, but we can still see sudden changes in this chart as well. When this happens, that typically means that the security is overbought or oversold – just experiencing a temporary shift that will likely be over quickly. 

In this instance, traders will often compare the MACD with the Relative Strength Index to double check whether the security is overbought or oversold. We’ll get deeper into this combo move below. 

MACD Pros and Cons ⚖️

The MACD chills out a stock chart and lets you see what is happening in the bigger picture. It’s a great way to see whether you should enter a long or short position, and whether a trend is slowing down or ramping up, indicating when you might want to buy or sell.

Like all indicators, it is not a crystal ball: divergence can show that a price reversal is possible, but it’s never guaranteed. There are false positives with the MACD. There are also changes in price that the MACD fails to predict. In addition, it should be used in tandem with other indicators to determine whether a security is overbought or oversold.

Pros

  • See a price trend over time
  • Decide whether to open a long position or short position 
  • Helps you find a good moment to buy or sell

Cons

  • Divergence can indicate price reversals that never happen, and miss other price reversals that do happen
  • Cannot 100% reliably indicate whether a security is overbought or oversold

How to Read MACD and RSI 📖

When the MACD is rising or falling quickly, that can mean that the security is overbought or oversold. This is useful information for day traders, who might want to know if a security is expected to return to normal fairly soon, and capitalize on that.

However, the MACD alone is not quite enough to confirm that the security is overbought or oversold. Many traders will therefore use it in tandem with the Relative Strength Index (RSI), another popular forex indicator. The RSI compares the security’s current price to its average gains and losses over a certain time period. 

Alternatives to MACD 📜

If MACD isn’t your speed, don’t worry – there are plenty of other indicators that can also show you whether a price is trending upward or downward, and when a price reversal might take place.

  • Bollinger Bands. These bands compare how a price is changing to how it has changed over a certain period of time. When a security goes outside the range of the band, that indicates a price reversal will likely happen soon.
  • Ichimoku Cloud. This indicator is a bit complicated, but if a security goes below the cloud, it’s a great time to buy – and if a security goes below the cloud, it’s often a great time to sell.
  • Parabolic Stop and Reverse. As the name suggests, this tool helps you determine when a price might reverse by placing dots that quickly show you how a price is trending. 

Conclusion 💡

When trading stocks or forex, there are plenty of ways you can try to gain the upper hand. It’s important to stay on top of strategies, especially with the forex market seeing more and more traders every day – and even taking over Instagram. Not every indicator is going to make sense to your brain and for your specific trading strategy – but it’s great to familiarize yourself with all of them, and figure out which can be valuable parts of your toolbox.

With the Moving Average Convergence Divergence, you can slow down those ever-changing prices enough to get a handle on how a security is trending. Remember, it doesn’t tell you everything you need to know – but before you’re opening a long or short position, check out the MACD and see if you like what those lines are telling you.

MACD FAQs

  • How is MACD Calculated?

    The Moving Average Convergence Divergence (MACD) is the difference between one moving average taken over a shorter time period, and a second moving average taken over a longer time period.

  • What Does MACD Stand For?

    MACD stands for Moving Average Convergence Divergence. 

  • Which MACD Setting is Best?

    The standard setting for MACD is 12, 26, 9. This means the shorter moving average is taken over 12 time periods; the longer moving average is taken over 26 time periods; and the signal line compares them over 9 time periods.

  • What is a MACD Histogram?

    A MACD histogram is a graph showing the distance between the MACD and the signal line. This can help traders identify momentum in the trend.

  • How do you read MACD 12 26 9?

    The first number refers to the number of time periods used to calculate the faster moving average. The second number refers to the number of time periods used to calculate the slower moving averages. The third number refers to the number of time periods used to compare the two moving averages through the signal line.

  • What is a Slow MACD?

    The slower MACD refers to the moving average calculated over more time periods. 

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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

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