What is the MACD and how does it work?

Continuing with the lessons of the trading training started a few weeks ago, we have been learning what the moving averages or bollinger bands and how beneficial they can be for our operations. Today we will continue with a very useful indicator, it may seem a little more complicated than those described above but, if you pay attention, you will learn to use one of the most effective indicators within technical analysis. Yes, we are going to talk about the MACD and the advantages it provides us for our trading training.

What is MACD?

The MACD (Moving Average Convergence Divergence) is one of the best known and most used indicators. It is a very useful indicator for your trading training since it is versatile in any type of financial market for trading. This indicator was created by Gerard Apple with the intention of providing investors with the possibility of following the trend of an asset in the form of an oscillator. This indicator at first glance may seem complicated to understand since we see that it is made up of two colored lines and bars that rise and fall below a level. But it really is very simple and useful. Let's see how it works...

How does the MACD work?⚙️​

As we have done in previous posts, the fundamental thing in training in trading on indicators is to understand how they are made up and how they work. The MACD indicator is mainly made up of two lines and some bars that we can see between these lines:

• The blue line is known by the name MACD. It is made up of two exponential moving averages that are configured in 12 and 26 periods. Next, a subtraction is made between the value of the two averages to obtain the line that defines the MACD.

• Next we can see an orange line, known as the signal. This line is another calculation of an exponential moving average, but in this case we configure it with 9 periods instead of 12 or 26. This line, as its name indicates, gives us a signal to define if the price intends to go to the up or down. In this way, we can decide whether to buy or sell, as long as the signal crosses the MACD line or the zero line.

• Last but not least, we can see some horizontal bars that change color (green or red) in the middle of the MACD lines and the signal. These bars are called MACDh, they show us at all times the difference that exists between the two lines. They help us to keep track of the historical correlation between the two means defined above.

Is there a strategy to take advantage of the MACD?

Of course, it would not be good trading training if we did not provide you with strategies to take advantage of the indicators. Specifically for this indicator we bring you two simple but effective strategies if we use them wisely:

1. Crossing of the MACD line to the Signal line

This strategy is the simplest that we can use in our operations with the MACD indicator. It simply consists of waiting for a crossover between the two lines of the indicator, always being the MACD line (blue line) that leads the orchestra. In detail, when the MACD line crosses above the signal line, we position ourselves long. On the other hand, when the MACD line falls below the signal line, we position ourselves short. As we can see in the image below, in order to take advantage of bullish movements, it is enough to enter when the mentioned lines cross (preferably below the 0 level).

We see how the MACD's path is above the signal at all times. We recommend that you analyze the inclination of the MACD, since it can give us advance signals of the optimal time to exit. It is also convenient to see how the histogram is, since it gives us signs of trend exhaustion for a possible reversal in price. When we see that the MACD crosses below the signal, it is time to close our long operation to collect profits. On the other hand, we can open a short the moment we see the MACD falling below the signal (in an area above 0). The histogram can also help us exit the operation, at the moment when an upward crossover is about to be made and the histogram stops showing signs of falling.

2. The two lines cross the zero line

Another of the strategies that we are going to show you in this MACD trading training is similar to one that we explained in the article on moving averages. It basically consists of waiting for a crossing of the two lines above zero to have a bullish entry signal. To achieve bearish entries it would be the same procedure but in reverse, waiting for the moment when these lines cross below the zero level. It should be noted that there are two delimited areas that we have already been able to see, the purchase area and the sale area. These two zones are delimited by the zero level, as we will see in other indicators that we will explain soon.

As we see in the chart above, the moment the MACD and the signal cross above the zero level, the price begins the upward movement. We see the strength of the price in not falling below the original entry level when a bearish movement is made in the MACD. Even so, the price manages to stay above the entry price, managing to make a second upward crossing above zero that leads the price up again. We recommend that when making entries, the lines are well positioned based on your prediction. That is, if we make a purchase when the MACD crosses above the signal at a level well below zero, we have a greater chance of success than when making the operation in an indecisive cross close to zero.

3. Divergences between MACD and price

As with many indicators, there are times when the indicator and the price do not agree on the direction that the asset in question is taking. We know these events as divergences, and they are a great way to detect trend changes in prices. There are times they are obvious and other times they are hidden more than a needle in a haystack. Of course, a divergence does not guarantee a trend turn. We must interpret it as a warning of a high probability of a trend reversal, even if it does not always end up happening. With the following explanation, within this indicator we can differentiate three types of divergence; a double divergence of MACD and MACDh or a single divergence of MACD or MACDh.

As we see in the chart above, we see how the MACD crosses below the signal, which we could interpret as a bearish signal. But immediately we see how the price then recovers and continues its upward path, which is why this divergence between the MACD and the price served as a signal (somewhat difficult to see) of a small setback in the price to continue with the tendency.

Conclusions from this trading training

As we have seen throughout this article, the MACD is one of the easiest indicators to learn to use and at the same time with a good level of effectiveness if we use it correctly. We remember that it is advisable to enter areas where the crossing of the lines is clearly defined for the next movement that is going to occur. At the same time, as in any trading training that we carry out, it is advisable to use indicators in support of others (such as volume, moving averages or others) in order to obtain more precise buy or sell signals.