Using MACD Indicator in Trading

What Is MACD?

One of the most popular indicators, Moving Average Convergence/Divergence or MACD, is a tool that follows trends and measures a stock’s momentum. These trends show two moving averages of a particular security price and calculate how these moving averages converge or diverge.

The MACD Indicator tracks the difference between slow and fast averages on a specific duration. Often, traders use the 12-day exponential moving average or EMA — that tracks the investment’s price over a period of time for the slow average and the 26-day EMA for the fast average. The MACD is then computed by subtracting the 26-day EMA from the 12-day EMA. This helps traders identify trends in the chart and decide on their next action.

Take note, though, that you don’t have to use 26-day and 12-day EMAs. You can choose whatever EMAs that are best suited for you and the factors you want to consider.

MACD Formula

The formula for MACD Indicator is the following:

• MACD Line = Short EMA – Long EMA
• Short EMA = exponential moving average of the closing price with a shorter period length
• Long EMA = exponential moving average of the closing price with a longer period length

Some traders opt to use a signal line as well. This signal line is often a 9-day EMA that crosses over or below the MACD Indicator. Traders use the points where the signal line and MACD meet to know potential buy and sells.

There is a lot of ways that the MACD can be used, but the common methods are the following.

Crossovers, or the point where two lines meet in the chart, can be used to know how oversold or overbought the market is. This can be deduced depending on the speed of the crossovers. These crossovers can last for days to weeks and are reliant on the strength of the movement.

There are two popular crossovers in MACD:

• The Bullish Crossover happens when the MACD crosses above zero. When MACD goes up from below to above the signal line, some traders consider this a signal to buy.
• On the other hand, the Bearish Crossover is described when the line crosses below zero. When the MACD crosses from above to below the signal line, traders consider this a signal to sell or short the security.

Both crossovers must be further from the zero line to indicate that the signal is strong.

Some traders also add a Histogram in their charts, and these are also used to see crossovers. Histograms also plot positive and negative values that coincide with the MACD. These values are used to gather data and give the trader a visual presentation of the possible trends that already happened. 

What Are the Advantages of Using MACD?

MACD’s ability to help the trader determine trend reversals is one of the significant advantages of using this indicator. Knowing these trend reversals is vital as it provides entry and exit points for the trader that simple moving average indicators can’t do.

Other advantages of trading with MACD are the following:

• It provides sufficient signals despite it being a simple indicator.
• It signals the trader about the strength of the trend.
• It gives updated information compared to other indicators.

What Are the Disadvantages of Using MACD?

On the other hand, there are downsides:

• MACD is a lagging indicator, meaning that even if you see the signal, it’s guaranteed that you had already lost some profits.
• MACD Indicator is ideal for short-term trading, the longest being 26-day EMA. Using it, in the long run, is not advisable.
• Each market and assets have different MACD setups. Make sure you find the best that suits your stock.

MACD Indicator: Is This Indicator Worth Learning?

Anything that can help you in trading is worth learning. The ability of MACD to forecast buy and sell trends makes it a popular option for traders to use, and using it along with other indicators can make your trading easier. Using other indicators such as relative strength index and stochastic oscillator can confirm the signals and momentum from MACD.

However, just like in other indicators, you should not rely too much on it as there will always be shocks that can cause the price to vary a lot and away from the trends, making the divergence and convergence irrelevant.

It’s crucial to establish how much risk you’re willing to take and carefully plan your actions when trading. Know your risk tolerance and how much you can afford to lose before trying your hand in trading.

Research the indicators that work best for you and take advantage of them. The MACD Indicator helps the trader know if a stock’s price is strengthening or weakening, and it’s one of the most used indicators. However, it’s still important to be alert and know the current trends and news that may affect your trading.