MACD meaning is “Moving Average Convergence Divergence”, and it is an oscillator-type indicator that is widely used by traders for technical analysis (TA). MACD is a trend-following tool that makes use of moving averages to evaluate the momentum of a stock, cryptocurrency, or another tradeable asset. Additionally, it is useful for identifying possible price trends and is utilised by many traders to spot potential entry and exit points. MACD uses the concept of moving averages to function.
How does MACD work?
Now that you understand MACD meaning, we will talk about how it works.
The MACD indicator is generated by subtracting two exponential moving averages (EMAs) to create the main line (MACD line), which is then used to calculate another EMA that represents the signal line.
In addition, there is the MACD histogram, which is calculated based on the differences between those two lines. The histogram, along with the other two lines, fluctuates above and below a centerline, which is also known as the zero line. We will be talking about the three important elements in the MACD indicator.
The MACD line
In general, the exponential moving averages are measured according to the closing prices of an asset, and the periods used to calculate the two EMAs are usually set as 12 periods (faster) and 26 periods (slower). The period may be configured in different ways (minutes, hours, days, weeks, months), but this article will focus on daily settings. Still, the MACD indicator may be toggled to accommodate different trading strategies.
The MACD line is calculated by subtracting the 26-day EMA from the 12-day EMA.
The signal line
By default, the signal line is calculated from a 9-day EMA of the main line and, as such, provides further insights into its previous movements.
The MACD histogram
The histogram is nothing more than a visual record of the relative movements of the MACD line and the signal line. It is simply calculated by subtracting one from the other.
Some tips on reading MACD
Centerline crossovers
Centerline crossovers happen when the MACD line moves either on the positive or negative area. When it crosses above the centerline, the positive MACD value indicates that the 12-day EMA is greater than the 26-day. In contrast, a negative MACD is shown when the MACD line crosses below the centerline, meaning that the 26-day average is higher than the 12-day. In other terms, a positive MACD line suggests a stronger upside momentum, while a negative one may indicate a stronger drive to the downside.
Signal line crossover
When the MACD line crosses above the signal line, traders often interpret it as a potential buying opportunity (entry point). On the other hand, when the MACD line crosses below the signal line, traders tend to consider it a selling opportunity (exit point).
While the signal crossovers can be helpful, they are not always reliable. It is also worth considering where they take place in the chart as a way to minimize the risks. For instance, if the crossover calls for a buy but the MACD line indicator is below the centerline (negative), market conditions may still be considered bearish. Conversely, if a signal line crossover indicates a potential selling point, but the MACD line indicator is positive (above the zero line), market conditions are still likely to be bullish. In such a scenario, following the sell signal may carry more risk (considering the larger trend).
MACD and price divergences
MACD charts may also provide insights through divergences between the MACD chart and the asset’s price action.
For example, if the price action of a cryptocurrency makes a higher high while the MACD creates a lower high, we would have a bearish divergence, indicating that despite the price increase, the upside momentum (buying pressure) is not as strong as it was. Bearish divergences are usually interpreted as selling opportunities because they tend to precede price reversals.
On the contrary, if the MACD line forms two rising lows that align with two falling lows on the asset price, then this is considered a bullish divergence, suggesting that despite the price decrease the buying pressure is stronger. Bullish divergences tend to precede price reversals, potentially indicating a short-term bottom (from a downtrend to an uptrend).
In Conclusion
We hope that through this article you understand more about MACD meaning and its various uses in helping us calculating market momentum and identifying when to enter or exit a position.
