Technical analysis is about the analysis of charts and making decisions based on the previous repetitive patterns. By the way, should we analyze the charts of all cryptocurrencies we want to invest in by hand? The answer is definitely NO. Considering the large number of cryptocurrencies, and their relatively long lifespan, this is practically impossible. Indicators are here to help us with this issue. They gather the data, order it, and represent it in a meaningful way. We, as users, only have to learn how to interpret them correctly, and how to use them efficiently. In this article, we will go through one of the most famous technical indicators called MACD. Stay with us to figure out what MACD indicator is and what signals it generates.
What is MACD?
MACD is one of the most popular, most practical, and at the same time simplest technical indicators. The word MACD stands for “Moving Average Convergence Divergence”. So, as the name suggests, it indicates the relationship between two moving averages (MAs). After adding the MACD indicator to the price chart, you usually see three numbers, which are time parameters. The first number from the left is the number of periods used for calculating the faster MA, the second number is the number of periods used for the slower MA, and the third number is the number of periods used for the MA that shows the difference between these two MAs.
These periods are by default shown with the numbers 9, 26, and 12. Users who seek for more sensitivity can change the numbers manually. For example, the MACD (5, 35, 5) is more sensitive than the MACD (12, 26, 9), and therefore is more appropriate for larger timeframes like weekly timeframes.
MACD consists of three lines: the MACD line, the signal line, and the histogram MACD line.
• The MACD line = the 12-day exponential moving average – the 26-day exponential moving average
• The signal line = the 9-day exponential moving average of the MACD line
• The histogram MACD = the signal line – the MACD line
So, we figured out that the MACD line is calculated by subtracting the 26-day moving average from the 12-day moving average. The line that shows the exponential moving average of the MACD line itself is also called the signal line since this is the line that generates buy and sell signals. The MACD indicator is usually accompanied with a bar chart or a “histogram” the shows the space between the MACD line and the signal line.
MACD trading signals
Up to here, we figured out what MACD is, what parts it consists of, and what meanings its numbers and lines have. However, the most important application of any indicator is its signals. So, in this part, we will go through some of the most widely-used signals of the MACD indicator.
The signal line cross
The signal line cross has two types of bullish and bearish. The bullish signal line cross happens when the MACD line crosses from below to above the signal line. This usually shows a good time to buy. On the other hand, the bearish signal line cross happens when the MACD line crosses from above to below the signal line. This usually shows a good time to sell.
The baseline cross
This signal is related to when the MACD line crosses the baseline. The bullish cross happens when the MACD line crosses from below to above the baseline, and the bearish cross happens when the MACD line crosses from above to below the baseline. The bullish base line cross usually shows a buy signal, and the bearish base line cross usually shows a sell signal. However, we insist that this signal is NOT enough by itself, and has to be combined with the other ones.
The word “divergence” refers to when the indicator and the price chart show different patterns. For example, when the indicator is bullish and the price chart is bearish, and vice versa, we say a divergence has happened. A divergence is usually a sign of potential trend reversal. In case of a bearish (or negative) divergence, the price chart shows a bullish move, but the indicator is bearish. In more technical terms, the price chart makes higher highs, but the indicator shows lower highs. This means that the bullish trend doesn’t have enough strength, and a bearish trend is about to happen. You can see the overall shape of a bearish divergence in the image below:
A bullish divergence is exactly the opposite point of the bearish type. It refers to when the price chart makes lower highs, but the indicator shows higher highs. This signal indicates a potential bullish trend. The overall shape of a bullish divergence is depicted in the image below:
You have definitely figured out that MACD is an indicator that shows the relationship between two other indicators, or two other moving averages. For this reason, it is practical and precise. MACD’s most important signals are the ones we explained throughout the article: the signal line cross, the baseline cross, and the divergence signal. However, more professional trades usually don’t rely on a single signal, and try to minimize the risk of false signals by combining them. Have you ever used MACD in your trades? Have you found it useful? Share your experiences with us.