How to use MACD effectively

  • How to use MACD effectively

    When you run the Metatrader 4 trading platform, there you will find the MACD indicator. This indicator is very popular with stock and forex traders and is also used in crypto trading.

    This indicator can be used for both short and long term trading, and some traders combine it with other indicators to get better trading signals. In short, MACD stands for Moving Average Convergence Divergence and is included in the Oscillator indicator group.

    How to use MACD effectively, find the answer in this article. But before get in the core, I will explain the MACD indicator first.

    What is the MACD indicator?

    MACD or Moving Average Convergence Divergence is an indicator developed by Gerald Appel and takes the formulation similar to the Moving Average. This indicator consists of two parts, namely MACD histogram and MACD line itself. Inline, MACD is divided into three parts, namely trigger line, centerline, and MACD line.

    MACD shows the direction of the trend and market momentum. In general, MACD is used as:

    • Measuring the strength of the trend.

    • Measuring market momentum, whether the conditions are overbought or oversold.

    • As an indicator of a bullish or bearish divergence. This function is quite popular because the results can be accurate if the signal occurs along with the overbought or oversold market momentum.

    There are several display versions of MACD in the trading platform but basically, represent the same parameters. The appearance of the standard version of the Metatrader platform uses an area to declare MACD, but the line version is more popular because it's easy to observe.

    In Metatrader, we can install the MACD indicator by clicking Insert >>> Indicators >>> Oscillators >>> MACD. Later the MACD indicator will appear automatically in a new window below the price chart.

    MACD includes an oscillator indicator that functions to detect overbought and oversold by analyzing changes between long and short-term moving averages.

    The difference between the MACD and the signal line is often calculated and expressed not in the form of a line but the form of a histogram bar chart, this development was made by Thomas Aspray in 1986.

    MACD Main Element

    The three important components of MACD are:

    • MACD line

    • Signal line.

    • MACD histogram

    MACD line

    The MACD line is the distance of two Exponential Moving Averages, where one EMA with 12 periods and another EMA with 26 periods s (EMA12 - EMA26). Whenever MACD reaches the zero level, there is no difference between the EMA.

    When there is a gap between two EMAs, the MACD line will move away from the zero lines. The bigger the difference, the farther the MACD line will be.

    Signal line

    The signal line is a smooth MACD. By default, this line is calculated from the average value of the previous 9 periods. The signal line is a slow version of the MACD line. This line is a slow-moving average that periodically intersects the faster MACD.

    MACD histogram

    The MACD histogram describes how much distance is between the MACD and the signal line. When crossed, no bars are visible. Conversely, the bars will get longer as the MACD line and its average signal line are getting further apart. Bars change polarity. The bar will form above the zero levels when the price goes up and will form below zero when the price goes down.

    How to read MACD

    To read MACD we must know its function first because this will make it easier to do analysis based on MACD.

    The function of the MACD indicator is to show the trend direction and market momentum. This function is the most commonly used.

    The way to read it is to look at MACD against level 0. If it is above level 0 then the trend is up, otherwise, if it is below level 0 the trend is going down.

    How to read MACD to analyze momentum by paying attention to the histogram bars. If the histogram bar is full and is above the 0 levels, it is considered overbought. Conversely, if the histogram bar is full and below the 0 levels it is considered oversold.

    Meanwhile, the market momentum is said to be starting to weaken when the histogram bars are getting shorter.

    And MACD as an entry signal is to look at the cross between MACD and EMA, a Buy signal if EMA 12 intersects EMA 26 from bottom to top. Sell ​​signal if EMA 12 crosses EMA 26 from top to bottom.

    If we read more carefully, MACD signals seem to be late because the EMA used includes lagging indicators. And also sometimes a false signal occurs after the cross, but it turns out that the price does not form a new trend, it even becomes sideways.

    So to read MACD still requires an understanding of price action and pays attention to territory support and resistance.

    The Histogram on the MACD Indicator (OSMA)

    OSMA (Oscillator's Moving Average) or commonly called a histogram is a difference between the MACD value and the signal line. On the Metatrader standard platform, the indicator that is part of MACD is called OSMA and is presented separately from the MACD indicator; while on other trading platforms, MACD and histograms are displayed together. 

    However, there are also some brokers with the Metatrader platform that make a display that is unified as in the line drawing above.

    OSMA can be used as a separate indicator from MACD. Many traders consider the histogram indicator to be more important than MACD itself. 

    As shown in the picture above, the area of ​​the histogram is positive (greater zero) when the MACD is above the signal lines, and negative when the MACD is below the signal lines. This shows the acceleration of price movements which means the strength of the current trend.

    The wider the histogram area, means the price movements will be faster, indicated by the wider MACD and signal lines, so the trend is getting stronger. The area histogram above the zero lines indicates a bullish state, while the histogram below the zero lines indicates a bearish state. The peak and valley levels of the histogram also show overbought and oversold levels.

    How to Use the MACD Indicator

    MACD hooked

    MACD is hooked, this is a temporary counter-trend signal when the market is trending strongly during downtrend and uptrend.

    Traders will see that the EMA and MACD lines are often involved, but there is no crossover to signal a trend change.

    Thus, the way to determine the position with the MACD hooked to each other is to follow the current trend. For example, the current trend is a downtrend, so traders wait for the MACD line and the EMA hooked with each other and then cross the current trend and then open Sell.

    Likewise, when an uptrend is waiting for the MACD line and EMA hooked with each other, then there is across from the bottom up following the current trend to open Buy.

    The image above is an example of a hooked MACD, in which a trader simply looks for entry after a pullback, which is indicated by the MACD line and the EMA line hooking up to one another.

    MACD crossover

    The next way to trade effectively with MACD is to take advantage of the MACD line and the EMA line after a crossover.

    But the important thing when using MACD for crosses is that not all cross conditions are good signals, you should also pay attention to the following.

    • If the signal line is above the 0 levels, the only trading advice is to open buy by waiting for a cross between the MACD line and the signal line from below to above. When the signal line is above the 0 levels it is not allowed to open a Sell position.

    • Conversely, if the signal line is below the 0 levels, it is advisable to only look for opportunities to open Sell positions, and it is not recommended to open Buy positions.

    You may rarely find a crossover signal if you have to wait when the signal line is above the 0 levels, but this is a way of managing a trading strategy more effectively.

    MACD Divergence

    MACD divergence is a trading signal that provides more than 80% accuracy, this indicator is the mainstay of some traders to spot trend changes through divergences.

    There are two conditions for MACD divergence, they are Bullish divergence and bearish divergence.

    Bullish divergence is indicated by a trendline in the price which shows a low to lower low on the descending line. However, the trendline on the MACD line shows the upward line.

    Usually, if this divergence pattern appears, traders will choose the Buy option because it will be possible as a change in the bearish trend to bullish. The image below is an example of MACD bullish divergence.

    The example above is MACD bullish divergence, while for MACD bearish divergence is just the opposite of the above conditions, where the price chart shows a trendline forming a Low to lower high that is pointing up, while the MACD trend line shows a downward direction if drawn from peak to next peak.

    Histogram Squeeze MACD

    The Squeeze histogram indicates that the market conditions are moving tightly, this is a sideways condition, which after this condition ends there is a possibility that a significant spike in price will occur.

    In this condition the histogram bars are very short and tight at level 0, there is no movement momentum.

    However, price conditions will not always be like that until finally there is a significant spike in movement, which is indicated by the longer the histogram bar.

    If the momentum after the squeeze histogram is below the 0 levels, the recommendation order is Sell, and if it is above the 0 levels the recommendation order is Buy.

    In the MACD squeeze histogram strategy, one thing to pay attention to is the length of the histogram bars; these must be short and parallel bars in the range of the zero levels.

    Then while watching the market from the candlestick pattern that is formed, the sideways are marked by a sequence of parallel candlesticks in a thin range.

    If these conditions are met then traders are waiting for a setup breakout, paying attention to the price action, MACD line, and the signal line, then the histogram bar should extend.

    MACD strategy target profit and stop-loss

    It cannot be denied that in all strategies it takes time to exit the market, this is related to target profit and stop-loss as part of risk management.

    MACD strategy should also pay attention to this and apply it in trading.

    There are two ways to determine the exit time

    The first is to determine the target and stop-loss based on the risk-reward ratio, it is better if a reasonable target does not set too big. Ideally, 30 pips is a good average looking at daily moving averages. For stop-loss, it can also be 30 pips as a 1: 1 risk-reward ratio.

    The second way is to determine certain parameters, for example after an active position is open if after three candlesticks the trend starts to weaken, that's when to exit. Or you can improvise with additional indicators, like the Fibonacci golden ratio, etc.

    Bottom line

    MACD is a multifunctional indicator, and it is very popular among stock and forex traders and even crypto traders have adopted this indicator a lot.

    The method above is an effective way to use MACD to train disciplined traders in seizing the opportunities available in the market.

    In the development of strategy, some traders not only use MACD but in combination with other indicators such as RSI, moving average, Bollinger band, etc.

    Trader's experience will ultimately provide the answer to success, get inspiration from successful traders to spur your enthusiasm.