Trading With MACD

The Moving Average Convergence/Divergence (MACD) is a strategy which utilises moving average lines, which are created by previous price trends. It was developed by Gerald Appel in the 1970’s and in 1986, Thomas Aspray added a further component to it (the histogram) to bring it its current state.

Why Use MACD?

The MACD strategy can be used to isolate various signals, but it is most reliable when it is used to follow trends, and gauge the momentum of the trend. This is when the strategy is at its most effective, and is most forgiving to beginners and less experiences traders.

It is comprised of three indicators; the MACD line, the MACD signal line, and a histogram. The zero-line, or centre line, can also be used to inform the trader about price action, but we’ll set this aside for now to minimise confusion. Below is a chart featuring all three indicators with their corresponding labels.

 

There are various ways to use this strategy, but we’ll only be going through two of them here. The first method is to initiate a position when one of the MACD lines crosses over the other, which represents a change in trend. The second is by using the centre line crossover method – more on this below.

MACD LINE CROSSOVER

This is one of the most widely used trading techniques, and it is pretty self explanatory. Whenever the MACD line crosses over the signal line (or vice versa), it signals the end of a trend, and the trader should consider buying or selling. This is shown on the graph below.

CENTRE LINE CROSSOVER

The centre line method ignores the MACD signal line, and focuses only on the MACD line and the centre line. Whenever the MACD line crosses over the centre line, it is used as an indicator to initiate a position – see below.

Recalling that the MACD line represents the difference between the 12-period EMA and the 26-period EMA on the price chart, whenever the MACD line touches the centre line (which represents zero in value) the 12-period EMA and 26-period EMA are equal and the difference is zero.

Notice that this intersection directly correlates with an intersection (or crossover) of the two EMAs (MACD lines) on the price chart.

As with any other trading technique, the MACD strategy comes with its risks as it is based on previous price action. And like most oscillator indicators, it can provide false signals where there are no long-term trends. That being said, it does provide very strong predictive value and when used correctly, can help to lock in some very significant gains.