Good day everybody,
Welcome to CryptoGod-1's blog on all things crypto. Today we are going to continue the series on Technical Analysis (TA) and why it can be such an important asset for new or experienced traders. In this series I am covering some of the different Technical Analysis and Indicators which can be used to help determine market movement and sentiment when trading. For Part IV the focus will be on Moving Average Convergence Divergence (MACD).
Moving Average Convergence Divergence (MACD)
The MACD is a trend following momentum indicator, used to show the relationship between two moving averages of an assets price. These moving averages are the EMA prices, calculated by the trader to result in the MACD. This is a lagging indicator, due to the fact all of the data used within the MACD is based on historical price action of the specified asset. Therefore it lags behind the price, and often the change in price direction has happened before it is fully noted on the MACD. There are two lines used within the MACD TA, known as the signal line and the MACD. These fluctuate above and below a point known as the ZERO line on the MACD chart, and the crossover of these lines are used as indicators for buying or selling an asset. Users must also beware of the speed of these crossovers while also taking into account whether or not the lines are above or below the ZERO line. Some traders make use of histograms, which were developed by Thomas Aspray in 1986, along with the MACD lines to predict if a change in price action or trend is about to occur. This makes the MACD a leading indicator for these traders, although it cannot always be considered accurate when used for future trend changes.
Calculating a MACD
To calculate the MACD a trader must first have the value of the 26-period exponential moving average (EMA), which was covered in Part I of this series, along with the 12-period EMA. To achieve the MACD the trader simply subtracts the 26-period EMA from the 12-period EMA. This results in the MACD line, while a nine day EMA known as the signal line is put on top of the MACD line. When the signal line is crossed over by the MACD is results in an indicator to buy or sell. Below is a simple formula for calculating the MACD line, which is then plotted along with the 9-Period EMA. Histograms, which can also be displayed on the graph as the users discretion, are simply calculated by subtracting the signal line from the MACD line.
MACD Line= 12-Period EMA − 26-Period EMA
Signal Line = 9-Period EMA
Histogram = MACD - Signal Line
How to use a MACD
The MACD is a very popular tool when it comes to TA, and generally a standard rule to follow when trading is when the MACD crosses above the signal line while both lines are below the ZERO line, it indicates the asset is oversold and a buy or long option would be a good trade. When the MACD line crosses below the signal line while both lines are above the ZERO line, it indicates the asset is overbought and a sell or short option would be a good trade. Traders need to also take into consideration the speed of which these crossovers happen, as this can be a signal of whether or not the market is overbought or oversold.
Some traders discount the significance of the ZERO line when trading with the MACD, but good practice indicates that it can be helpful in determining if a true reversal is taking place. It is just as acceptable to follow the above rules without including the ZERO line, meaning that when the MACD crosses below the signal line then it is time to sell as it is a bearish sign. When the MACD crosses above the signal line then it is time to buy as this is a bullish sign.
Histograms, as stated above, are taken by subtracting the signal line from the MACD line. They are a good indicator for the potential crossover, and therefore are seen as an indicator for an indicator. It is designed to identify convergence, divergence and crossovers, and remains in a positive state (above ZERO) when the MACD is above its signal line. Alternatively, when the signal line is below the MACD, the histogram is in a negative state (below ZERO). This can be an eastly indicator of a change in trend as the histograms will get smaller as they approach the ZERO line, ahead of the actual crossover.
Below is an example of a 15minute BTC/USDT Chart, showing the MACD graph below the candle chart. The signal line is in red, the MACD in green, and the histograms are in yellow. You can clearly see the ZERO line, as it is where the histograms change from up to down. As you look through the image, the signal line (red) is crossing above the MACD as the price increases, while the MACD crosses above the signal line as it decreases. The histogram always crosses from positive to negative, or negative to positive, at the moment of a crossover.
Often a MACD is used alongside an RSI indicator, which was covered in Part II of this series. This is because the RSI is an oscillator that calculates average price gains and losses over a given period of time, while the MACD measures the relationship between two EMAs. Together they can be used in tandem to give stronger indicators, although it can often be noted that while one is indicating a bearish signal, the other may not be. This is where divergence in either indicator may be very beneficial for a trader to note.
Divergence is noted when an anticipation of signal line crossovers with the MACD forms bullish and bearish divergences. Two main types of divergences when the signal is set to cross the MACD are known as peak through and slant.
Peak through divergences are created with two peaks in the MACD-Histogram. A bullish peak divergence forms when the MACD creates a lower low and the Histogram forms a higher low, indicating that an increase in the value of the asset could be about to take place. A bearish peak through divergence forms when the MACD creates a higher high but the Histogram shows a lower high, which can signal a sharp downturn in value for the asset.
A slant divergence forms without peaks and troughs, instead there is a slant along the histogram towards the ZERO line. When the histogram slants towards the ZERO line it reflects a convergence between the MACD and the signal line, i.e. they are getting closer to each other. When the histogram is expanding this is showing strength in momentum while the MACD is also moving away from the signal line. As momentum slows, the histogram contracts and moves closer to the ZERO line, while at the same time the MACD is moving closer to the signal line. This is an indication that a crossover is due to happen.
The below example highlights when divergence occurs, as the lines on the chart show below. The Yellow & Pink circles highlight the Peak Through bearish divergence, as the MACD line is posting higher highs (green line), and the histogram is showing a lower high. As shown on the price chat, soon after the price fell. The white line also shows a slant divergence as the histogram lowered in depth towards the ZERO line, while the price rose. Finally the blue arrows show where crossovers took place, both of them when the MACD line crossed the signal line while they were both below the zero line. The next candles on the chart showed high momentum in price movement.
Limitations of a MACD
When trading, using a MACD comes with the problem of divergence, which can signal a possible reversal in the price of an asset but no actual reversal takes place. This is known as a false positive. Another problem with the MACD divergence is that it can sometimes miss a reversal which does take place, meaning it doesn't forecast every reversal and cannot be considered fully reliable due to this. In other words, it predicts too many reversals that don't occur and not enough real price reversals. The common problem of a false positive generally is seen to happen when the price of an asset is moving sideways or trading in a range. Due to the fact the MACD will move back towards the zero line when a slowdown in momentum or slow trending movement happens, the MACD will pull away from its prior extremes when a true reversal is not taking place.
Conclusion on using a MACD for TA
As a trader, whether it be day trading or long term trading, using the MACD can be very beneficial in in spotting when a reversal in the current trend is taking place via a crossover of the MACD line and the signal line. It should not be taken as a direct signal for inputting a trade, instead it can be a useful tool in determining when a reversal may happen. The divergences coupled with the use of a histogram can increase the reliability and foresight of the indicators from the MACD, which is a lagging indicator by default. It may be combined with a RSI indicator to make it a useful in being ahead of the trend. Therefore the histograms are seen as an early warning system for when crossovers, which are the most frequent MACD signal, will happen.
As stated whether you are experienced or new, Technical Analysis can always be a useful asset when trading. Just remember it is not guaranteed and nobody can predict the future, no matter how certain you believe the patterns to be. It is always just another tool of the trade to help make more informed decisions when trading. It can be easy to fall into the trap of thinking if the histogram or MACD line is dropping then the price will fall, but it is as important to watch the overall asset trend and take not of the ZERO line. It is important to use MACD along with other TA, such as RSI, to get the correct signals for buying and selling. Always zoom out, if trading on a 15 minute chart check the 1 hour or 4 hour or even 1 day chart to give you a better idea of the overall position of the MACD and signal lines, and if a crossover of a larger trend is due to take place compared to a short term trend.
You can find the previous parts to the series here:
Technical Analysis - Part I - Exponential Moving Average (EMA)
Technical Analysis - Part II - Relative Strength Index (RSI)
Technical Analysis - Part III - Bollinger Bands (BB)
I hope this post was beneficial and of some use, and I plan on continuing the series with the next instalment focusing on the On-Balance Volume (OBV). Of course each technical analysis provides different beneficial information, so combining your most trusted and favourite ones can be the best strategy for finding entry and exit points when trading.
Have a great day.
Peace. CryptoGod-1.
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