Understanding and knowing how to read MACD indicator is important for success in trading. It gives you reliable buy and sell signals.
Reading MACD or Moving Average Convergence Divergence is an important part of technical analysis. MACD is a technical oscillator. In fact, MACD is a dual indicator. This is because it has characteristics of an oscillator as well as a moving average.
MACD indicator was developed by Gerald Appel. It is considered as a more reliable and important technical indicator.
It is important that as a trader you know how to read MACD.
When plotted on a graph, we see that MACD oscillator is made up of two lines :
1. MACD Line
2. Signal Line
MACD Line, also known as faster Line, is made up of difference of Exponential Moving Averages for closing prices of two time periods. These two time periods are usually 12 and 26. It can be 12 and 26 days or 12 and 26 weeks, depending upon how you want to use it.
The MACD signal line, also known as slower line, involves exponential moving average of closing prices of the security. It can be for a period of 9 days or 9 weeks. Most commonly used set of numbers to draw MACD is 9, 12 and 26. However, you can adjust these numbers according to your trading preferences.
As with other technical indicators and moving averages, we need not to calculate them and draw those graphs. The charting software do it by themselves.
Moving Average Convergence Divergence or MACD lines keep oscillating above or below the zero line. This is a character of a technical oscillator and that is why MACD is an oscillator.
How To Read MACD Indicator
We look for MACD crossover and signal line while reading MACD indicator for trading signals. These crossovers may occur above the zero line or below the zero line. Crossovers above or below the zero line have their own significance.
Buy Signal – A buy signal is generated when the MACD line crosses above the signal line. MACD crossover happening far below the zero line is more significant. MACD bullish crossover can be the best buy signal.
The reason is that the area below the zero line corresponds to oversold zone. The more away we are from the zero line the more is the oversold situation. The area above the zero line corresponds to overbought zone. The farther we are from the zero line more is the overbought situation.
Some traders may use zero line crossovers as the buy signals and some even trade the crossovers happening above the zero line.
Sell Signal – A sell signal is generated when the MACD crossover is below the signal line. As we talked above, the more appropriate or reliable sell signal may be generated when the MACD 2 lines crossovers happen far above the zero line which is the highly overbought region.
MACD divergences happen when the MACD indicators move opposite to the security prices. MACD bullish divergence is one in which the security prices are moving lower while the MACD is moving higher. This indicates that the bottom for security prices is in place and prices are likely to move higher in near future.
Bearish divergence MACD is when the security prices are moving higher while the MACD indicator has started moving lower. This indicates the prices are topping out and may move lower in future.
It is always better to use other technical indicators in conjunction with one indicator to compliment the interpretations. This also helps the traders to avoid the false trading signals.
MACD Settings For Day Trading
The current trading software mostly have a default MACD settings as 26, 12, 9. These values are for slow EMA, fast EMA and signal line.
These are the best MACD settings for day trading as well as positional trading. You do not need to change these settings. You can select daily or hourly chart as per your trading requirement for day trading or positional trading.
MACD Trading Strategy
We already know that combining more than one technical indicator gives more reliability to a trading signal. You can combine MACD to stochastics to give better trading signals. MACD and stochastic trading strategy works because the stochastics is based on the closing prices and the MACD is the convergence and divergence of the moving averages.
RSI and MACD indicator combination is another important combination. RSI is relative strength index indicator which gives trading signal based on the overbought and oversold conditions. Both make commonly used simple indicators. MACD RSI strategy combines the dual advantage of trend trading with MACD and giver rather accurate entry and exit level on the basis of RSI levels.
RSI and MACD strategy gives more reliable buy signal for long positions or short covering of short positions when MACD gives bullish crossover with RSI moving above the 30 level. For short selling or profit booking on long positions, the RSI should be at or below 70 with MACD bearish crossover.