The MACD is a strong and popular trading indicator that helps traders find potential entry and exit points by showing the momentum and direction of the trend in a market.
The MACD can be used effectively by understanding how it works, strategies for its application, and how a modified version can give more accurate insights. This post shall explore all these aspects.
Understanding the MACD Indicator
The MACD is obtained using two moving averages with periods of, typically, 12 and 26. Its components are presented here:
MACD Line
This is the difference between a 12-period and a 26-period EMA. Because this line is quick to respond to price changes, it therefore reflects the direction of the short-term trend.
Signal Line
It is the 9-period EMA of the MACD Line, performing as a smoother which confirms the trend direction and decreases the noise.
Histogram
A chart that shows the difference between the MACD Line and the Signal Line. It may be used to judge the strength of a trend.
How it Works – MACD
The MACD Line is actually plotted from the difference of two EMA or, a Fast and Slow MA: it is positive when above it—that is, when the 12-period EMA is greater than the 26-period one, which means an upside; vice versa, it is negative, if it goes below it—that is, the fast EMA crosses lower, the MACD Line goes below and indicates a downside.
Signal Line Cross Strategy
The basic signals are given when the MACD Line crosses over or under the Signal Line:
Bullish Signal: When the MACD Line crosses above the Signal Line, this is a reflection of increased bullish momentum. This could be a buy signal.
Bearish Signal: When the MACD Line crosses below the signal, it indicates that bearish momentum is right around the block and might give signals in selling.
Using the Zero Line
Another important approach is that one should monitor the zero line. The crossing of the zero line by the MACD Line can already show a change in the momentum of the trend:
Above the Zero Line
It shows bullish momentum. The greater the distance of the MACD Line from zero, the stronger the bullish trend.
Below the Zero Line
Indicates bearish momentum. A greater distance from zero means stronger bearish trend.
It helps traders to measure the big trend and shows them how to distinguish between short-term momentum and longer-term trends.
MACD Histogram as an Indicator of Momentum
The histogram helps visualize the strength of the trend:
Increasing Histogram
Tells that the MACD Line is moving further away from the Signal Line, which means the strength of the momentum in the direction of the trend is gaining.
Decreasing Histogram
MACD Line and the Signal Line come closer, implying that momentum is weakening.
A quick look at the histogram will help the traders decide on entry or exit from a trade.
Alternative Approach: MACD – Similar to RSI
The MACD indicator can be used similarly to the RSI. Despite the lack of overbought or oversold zones, as with the RSI it fluctuates between positive and negative values, making highs and lows. An overextension could thus again be read at the points of these extremes in this context:
MACD Extremes
The MACD reaches an extreme high or low. This could be interpreted as the market becoming overextended and in need of a turnaround.
Divergence
If the price continues in one direction and the MACD fails to make a new high or low, that can be a signal that the trend is weakening and might eventually turn in the other direction.
Improved MACD Strategy with the Improved Indicator
While the standard MACD has proven its worth, the Improved MACD Indicator carries extra features that make this analytical tool easier to use:
Colored Fills
The indicator fills the area of MACD with colored fills, either red or green, depending on whether the MACD Line is above or below the zero line.
Dynamic Bands
It contains yellow bands, which are like the upper and lower thresholds of the RSI. These bands can be set according to the market conditions and help identify the overbought or oversold zones.
Alerts on Automatic
Green and red circles appear when the MACD crosses these dynamic bands, signaling possible reversals.
Example Application: The MACD Line crosses above the yellow upper band then falls below the Signal Line, it prints a red circle, meaning a potentially profitable sell trade for bears.
Benefits of the Optimised MACD
Clearer Visualization
The filled colors added make it quite easy to see, without having to refer to the zero line constantly, whether the MACD is bullish or bearish.
Alerts for Overbought/Oversold Conditions
Dynamic bands will keep you on track when momentum is overextended and potentially due for a reversal.
More Precise Signals
Automatic markers allow every potentially trading opportunity to be given a highlight at once.
Key Points to Remember
MACD Crosses
A simple yet powerful strategy for trading when the MACD Line crosses the Signal Line.
Zero Line Analysis
Useful for determining long-term momentum trends.
Histogram Strength
The higher it is, the stronger the momentum; the smaller the histogram, the weaker the trend.
Divergence
A discrepancy in price and MACD is usually the harbinger of reversals.
How to Access the Enhanced MACD Indicator
The Improved MACD Indicator is free, and you can add it to your charts to start using these strategies. If you want even more advanced tools, make sure to check out the Quantifica Patreon, where you can get access to the full library of premium indicators.
The conclusion is that the MACD is quite a flexible and powerful tool for trading in its proper usage. Using such understanding of its components with a signal line cross, zero-line analysis, and histogram momentum will already help the trader make reasonably informed decisions. The Improved MACD Indicator enhances this trading with the MACD using visual cues and dynamic bands.