Using MACD Indicator in Trading. Image credit: Pexels
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.
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.
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.
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.
What Are the Disadvantages of Using MACD?
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.