The MACD is one of the most widely used technical indicators in trading markets. So what’s the MACD indicator for? This article will explain the use of MACD in detail, as well as the meaning of divergence, gold cross, and death cross.
I. What is the MACD?
MACD is the abbreviation for Moving Average Convergence Divergence. Created by Gerald Appel in 1970, it is a time-old technical analysis tool that continues to be used today. The principle is that the intersecting trend of two “fast” and “slow” lines and the length of the oscillator provide the signal of entry.
II. Basic use of MACD
MACD is composed of two curves and a series of cylinders, one of which is called the DIF line and the other is called the MACD line.
Before we look at the MACD indicator, we must first understand EMA, Exponential Moving Average. Every day’s price has its importance, so investors will average the price of each day, forming a simple moving average (SMA). Often, however, the accuracy of the moving average is often distorted by the big rise and fall on a day far away from today. The original purpose of EMA is to avoid such situations by giving more weight to more recent prices and making the moving average more sensitive to recent price movements. On the contrary, the older the price is, the less weight is given to it. It can be seen from the above that EMA is calculated as a moving average calculated with different weights for each day.
The components of MACD are as follows:
DIF (closing price value) is formed by subtraction of two EMAs with different parameters. In general, the short-term value is set as 12 days and the long-term value is 26 days in the daily chart. The difference obtained is called “DIF”, which also represents the deviation of short-term EMA from long-term EMA, and it is called “fast line”.
2. MACD Line (Signal Line)
MACD is the 9-day EMA of the DIF. After a smoothing process, this line will be less sensitive to price than DIF line, so it is also called “slow line”, also known as DEM.
3. Oscillator (OSC or MACD bar)
In order to concretize the trend of the two lines, the DIF line and the MACD line are subtracted, and the difference is the length of the oscillator in the indicator
Basic interpretation of MACD
1. Both DIF line and MACD line are above axis 0 and continue to move upward, indicating that the market is in a bullish trend now and has a large probability to continue to rise upward.
2. Both DIF line and MACD line are below axis 0 and continue to move downward, which indicates that the market is in a bearish trend at present and has a large probability to decline further.
3. Both DIF line and MACD line are above axis 0 but continue to move down, which means that although the current price is in a bullish trend, it is likely to usher in a pullback.
4. Both the DIF line and the MACD line are below axis 0 but continue to move upward, which means that although the current price is in a bearish trend, there is a high probability of a rebound.
The MACD itself is the divergence and intersection of two moving averages, while the larger EMA parameter value in the indicator setting (i.e., the default value of EMA26) represents the “axis 0” in the indictor.
III. Understanding MACD gold cross/death cross, top/bottom divergence
Because MACD has the characteristic of moving average — directionality and is smoothed many times by means of exponential average, the MACD indicator can more accurately reflect the turn and change of the market. The indicator is composed of two lines and many oscillators. The lines can be interpreted in the way of the mean crossing. The length of the oscillator can be interpreted as the force in this direction. The signal interpretation is as follows:
1. MACD Gold Cross
When the DIF line crosses the MACD line from the bottom to the top below axis 0 and the oscillator turns from negative to positive, it indicates that the market may have bottomed out, with a high probability of reversal and an upward trend. This is one kind of MACD gold cross. It is recommended to go long at this time or close your short position.
When the DIF line crosses the MACD line from bottom to top above the 0 axis, and the column turns from negative to positive, it represents that this wave corrections may end, and the market is likely to rise again. This is one kind of MACD gold cross. It is recommended to hold or open a long position or close the short position at this time.
2. MACD death cross
When the DIF line crosses the MACD line from top to bottom and the oscillator turns from positive to negative, it means that this wave of rebound may be exhausted and the market is likely to fall again. This is a kind of MACD death crossover. It is suggested you open or hold the short position, or close the long position or at this time.
When the DIF line crosses the MACD line from top to bottom above the 0 axis, and the oscillator turns from positive to negative, it indicates that the market may have peaked and there is a high probability of reversal and a downward trend will be initiated. This is one kind of the MACD death cross. It is recommended to open a short position or close the long position at this time.
3. MACD divergence
MACD divergence refers to an action that moves against the MACD. This means that when prices reach a new high (low), the MACD does not make a new high (low) at the same time. This situation often comes from the fact that after a long period of rising (falling), rising (falling) momentum has been exhausted, leading to a change in the market. Thus, when a top (bottom) divergence occurs, there is a greater chance of a down (up) trend.
3-1) Top deviation
In the chart above, the market trend continues to reach new highs, but in the MACD indicator, the DIF line and the MACD line fail to follow the price moves. Instead, the highs continue to move down and the oscillators fail to give relative momentum. This signal indicates that the market may have reached a top and there is a high probability of a reversal. Traders with long positions can exit the market or go short at this time.
3 – 2) bottom divergence
In the chart above, the market trend continues to hit new lows, but in the MACD indicator, the DIF line and the MACD line fail to follow the prices moves.
Instead, the lows continue to move up and the oscillators fail to give relative momentum. This signal indicates that the market may have bottomed out, and there is a large probability of a reversal. Traders can close their short positions or open a long position at this time.
IV. Can MACD be set on MT4?
However, investors should be aware that the MACD indicator on the MT4 platform is significantly different from that of the general platform. In addition to no fast line, the drawing of oscillators is also different. So, it is suggested that investors find another chart website for reference.
V. Summary of MACD’s advantages and disadvantages
The MACD indicator is widely used in trading because it has a wide range of signals for investors to look at, not only the obvious gold or death cross to predict the market trend, but also the length of oscillator to provide a signal of momentum strength. Moreover, the MACD provides less noise than the moving average alone.
However, it should be noted that the MACD indicator also has the disadvantage of lag. During the consolidation, the fast and slow lines could be tangled, and the column may hover around the 0 axis. At this time, the indicator does not have too much reference value. In addition, in case of a correction, the MACD oscillator may fall below 0 axis and then rise up gain (as well as in case of a rebound). At this point, if investors only rely on the MACD indicator, it will increase the possibility of loss.
Therefore, it is important for investors to look at other technical indicator tools when using the MACD indicator to minimize the possibility of miscalculation and improve the chance of profit.
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