MACD indicator is the most popular technical analysis indicator used by all types of technical analysts and traders. Is MACD a good indicator for trading? In our view this is the best; traders use MACD indicator for intraday, swing trading, positional trading and in long term chart analysis also because it indicates the trend, momentum and strength of the price movement. Hence, it is both a leading indicator as well as a lagging indicator or it is known as a Hybrid Indicator.
Why is MACD a lagging indicator
MACD takes moving averages as its base for calculation and you know moving averages are trend following indicators or lagging indicators which follows past price movements and indicates the price trend, hence MACD is considered as a lagging indicator.
Why is MACD a leading indicator
MACD also indicates the strength and momentum of the price movement within a range of upper and lower limits and gives alerts or signals for entry and exit (buy and sell signals), hence MACD is considered as a leading indicator.
Definition of MACD indicator
The full form of MACD is Moving Average Convergence Divergence. MACD is a technical analysis indicator created by Gerald Appel in 1970s. It comprises of two lines those are a fast line or MACD line and a slow line or Signal line, which moves within a upper range (positive value) and lower range (negative value) with a base line at the point of zero (0). There is a histogram graph placed at the base line which shows the difference value between the two lines.
MACD indicator explanation
The MACD indicator is consist of three exponential moving averages and the MACD indicator best settings are the default setting used by most of the trading platforms, that is 12 period EMA, 26 period EMA and 9 period EMA, because it is scientifically proven and we should not change it.
The Fast line or the MACD line is calculated by subtracting the 26 period Exponential Moving Average (Slow Moving Average) from the 12 period Exponential Moving Average (Fast Moving Average).
MACD indicator formula = 12 EMA – 26 EMA
When the 12 period EMA, that indicates the short term price trend, is higher than the long term trend that is the 26 period EMA, then the value of the MACD line will be positive and the line will be in the upper part of the Base Line which indicates the current trend is bullish.
When the short term price trend (12 EMA) is lower than the long term trend (26 EMA) then the MACD line value will be negative and the line will move to the lower part of the Base Line which indicates the current trend is bearish.
Signal line formula = 9 period Exponential Moving Average of the MACD line
The Slow line or the Signal Line is the 9 period Exponential Moving Average of the MACD line which indicates the strength of the trend. When the MACD line is above the Signal line it indicates that the trend is higher than its 9 period Moving Average or the momentum is strong. And when MACD line is below the Signal line it indicates weakness in the momentum.
Histogram Formula = MACD Line – Signal Line
Histogram bars are placed on the base line (zero line) and indicates the differential value of the MACD line and Signal line shown in two colors – Green & Red. Green bar indicates increase in the value and Red bar indicates decrease in the value. When MACD value is more than the Signal line value then the value of Histogram will be positive and it will be above the base line which indicates trend is bullish. And when MACD value is less than Signal line then the Histogram value will be negative and will be placed below the base line facing downward indicating bearish trend.
When the Histogram changes its position and face from the upper part of the base line to lower part of the base line facing below it is called as bearish crossover, which indicates ending of bullish trend and beginning of a down trend. When histogram bars moves from lower part to the upper part facing upward, it is called as bullish crossover that indicates starting of a bullish trend.
Convergence & Divergence
Convergence simply means things coming together or joining together and Divergence means moving apart from each other. MACD calculates the Convergence & Divergence of moving averages and gives different signal according. As you know the MACD line value is the difference between the 12 EMA (short term trend) and 26 EMA (longer term trend), up move of MACD line indicates increase in short term trend and downward move of MACD indicates fall in trend. Both the cases are indication of either bullish or bearish divergence of moving averages. When the difference between the moving averages decreases (convergence of moving averages) then the MACD line becomes flat and come closer to the base line, this indicates price consolidation.
When the MACD line and Signal line move apart from each other it indicates higher momentum or strength in the trend (either bullish or bearish) and when it come together it shows momentum is falling and consolidation in price movement.
How to check MACD indicator
To add MACD indicator in the chart, go to Studies or Fx button, then search MACD and click it, this will add the MACD indicator below the chart with default settings. If you want to view or modify the settings, you can click on the settings icon on the left side corner. Here we have given instruction how to use MACD indicator in Zerodha web platform in the pictures below.
(We have used Zerodha web platform to show all the candlestick charts here and we personally also use Zerodha and Upstox for trading and investing in stock market.)
MACD indicator strategy
There are various methods on how to read MACD indicator and different strategies on and how to use the MACD indicator in trading and technical analysis. The basic concept is to identify the MACD indicator buy and sell signals and there are three common ways.
MACD & Signal line Crossover
When the MACD line cross above the Signal Line in upward direction, it indicates that the trend is increasing, which is a sign of bullishness and gives a Buy signal or to make long positions. At this time the Histogram shows a bullish crossover.
When the MACD line crosses below the Signal Line with downward move it indicates the trend is falling or beginning of a bearish trend. It gives Sell signal or to make short positions. At this time the Histogram shows a bearish crossover.
The importance of Buy and Sell signals increases if it occurs at some distance above or below the base line (Zero line). If the lines are near the base line then it indicates a sideways or consolidating market.
Some traders also give importance to the direction and reversal move of the MACD line with good angle. If the MACD line shows steep fall from the top level with good angle, it indicates the bullish trend may end and when the MACD line moves upward sharply from its low, it indicates starting of a bullish trend, both these conditions are sign of trend reversal and aggressive traders make positions at this point for short term gains.
MACD Base line or Center line Crossover
If the MACD line is below the Base line (zero line) then value of MACD is negative, it indicates the short term trend is bearish. When the MACD line cross the Base line or Centre line and moves upward entering in to positive value, it indicates a sign of increase in positive momentum and confirms the bullish signal.
When the MACD line crosses the Base line falling from the upper part, it indicates the momentum has been changed from positive to negative, which is a bearish signal.
MACD Bullish & Bearish Divergence
When the MACD line indicates opposite trend of the price chart, it is called as a divergence. When MACD line shows higher lows but price chart shows lower lows, it is called as bullish divergence or positive divergence. It indicates the price is falling but the strength is rising and the down trend may end very soon, hence traders find opportunities to take position.
When price chart shows higher highs but MACD line shows lower highs it indicates negative divergence or bearish divergence. It indicates the uptrend in price is becoming weaker and a down trend may start sooner, hence short term traders should book profit.
How to read RSI and MACD together
Traders often use different combinations of indicators for better analysis and confirmation of signals. Most of them use RSI indicator with the MACD in the Candlestick chart. Because RSI shows the strength of the price whether it is overbought or oversold & change in momentum and MACD indicates the trend of the price. If both the indicators give similar indications then it confirms the signals. Using both together gives a complete analysis of the price trend, momentum and strength. Therefore most of the traders use both of them.
Conclusion
MACD indicator is popular for its useful features and simplicity which a beginner also could understand and use. And our focus also is to provide useful knowledge and information in a simplistic manner that any level of learner could understand with very little efforts, for which we have tried to keep the content and language short & simple. We hope this article could be a basic MACD tutorial guide for beginners in stock market. In case you need any detailed information, you can search this topic in Google for more detailed content or you could check Wikipedia or Investopedia articles related to MACD. There are many YouTube channels which provide good learning videos, you can search them.
Disclaimer – Investing and trading in stock market is subject to market risk. We have to learn all the risk factors before making investment decisions. This article is only for basic knowledge about stock market investing for educational purposes only and not any type of recommendation. In case you need any professional advice please consult your financial advisor.
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