We have already described many technical analysis tools on our blog. How does MACD work? We will talk about this indicator now. The MACD (‘makdi') indicator was developed almost 50 years ago by Gerald Appel. The author's premise was to create an indicator that measured the strength and direction of a trend in the stock markets.
|→MACD is a widely used technical analysis indicator that helps determine trend strength and potential reversals.|
|→The indicator consists of the MACD line, a signal line, and a bar chart (histogram).|
|→By observing the interactions between these components, traders can make informed decisions about market trends and potential price movements.|
MACD indicator explained
MACD indicator is used to determine the current trend its strength and the probability of its reversal. It consists of the MACD line, a signal line, and the bar chart. We will discuss these 3 components of the indicator one by one.
The MACD line
The MACD line shows the difference between two EMA moving averages with different periods. When the MACD line crosses the zero line it indicates that there is no difference between them at this moment.
The larger the difference between two moving averages the further the MACD line is from the zero line.
The signal line
The signal line is a smooth MACD line. By default, the average value of the previous nine periods is used for calculation.
The signal line act as a slow moving average which is crossed by the fast MACD.
The bar chart displays the distance between the signal line and the MACD line. It changes its polarity relative to the zero line depending on the price movement direction. If the price goes upward the bar chart is above the baseline. If it goes downward the bar chart is below it. The MACD barchart is otherwise known as a histogram, as this is the type of chart it uses.
Pros and Cons 😊😞
|✔️Easy to understand and use for trend analysis|
|✔️Applicable to various financial instruments and timeframes|
|❌Possible false signals in sideways or range-bound markets|
|❌May lag behind actual price movements due to its calculation based on moving averages|
|MACD Line||Difference between two EMA moving averages with different periods|
|Signal Line||Smoothed MACD line, calculated using the average value of the previous nine periods|
|Bar Chart (Histogram)||Displays the distance between the signal line and the MACD line, showing the trend direction|
How do you read a MACD indicator?
To read MACD is to read the individual components of the indicator. Each component gives information about the current market situation. The standard indicator settings are 12,26 and 9. These are also the recommended settings, most traders use them and they work best.
You can change the indicator settings to set the periods for MACD and signal line moving averages which are measured in the number of candles.
When the signal line intersects the MACD line in an upward direction it indicates the possibility of price enhancement. Conversely, when the signal line intersects the MACD line in a downward direction it suggests a possible price reduction. The main advantage of the MACD indicator is its efficiency and simplicity. We encourage you to read also about combining MACD with PSAR.
We have discussed all the elements of the MACD indicator today. You are now able to answer the question: How does MACD work? Let what remains be your homework. Switch on the platform, open a chart of your favourite asset and put MACD on it. Find as many intersections of the MACD with the signal line as possible. Find situations where the histogram crosses the 0 line. Observe what happens following these situations. Nothing is more instructive in technical analysis than observation. So observe and draw conclusions. Do not forget to share them in the comments below the article.
We wish you a pleasant trading experience.
Q&A Section 💡
- Q: What is the primary purpose of the MACD indicator?
- A: The MACD indicator is used to determine the current trend, its strength, and the probability of its reversal.
- Q: How is the MACD line calculated?
- A: The MACD line is calculated by finding the difference between two EMA moving averages with different periods.
- Q: What are the standard settings for the MACD indicator?
- A: The standard settings for the MACD indicator are 12, 26, and 9 periods for the fast, slow, and signal line, respectively.
- Q: When does the MACD suggest a possible upward price movement?
- A: When the signal line intersects the MACD line in an upward direction, it indicates the possibility of a price increase.
- Q: What is the main disadvantage of the MACD indicator?
- A: The main disadvantage of the MACD indicator is the potential for false signals in sideways or range-bound markets, and it may lag behind actual price movements due to its reliance on moving averages.
GENERAL RISK WARNING
Kindly note that this article does not provide any investment advice. The information presented regarding past events or potential future developments is solely an opinion and cannot be guaranteed as factual, including the provided examples. We caution readers accordingly.
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