MACD Indicator. What is MACD? How to Use It & Best Settings

February 24, 2021 - Евгения Корнейчук

Moving averages are very important for observing and ascertaining the current trends, be they short or long. They are very often used for keeping an eye on the average prices for several recent periods. A combination of these periods is what comprises a moving average. There is a problem though.

To grasp a truly clear picture of the current trend situation, traders use many different indicators and parameters, which results in an extremely littered chart. That’s when oscillators, like MACD, come into play. So, what is MACD?

What is a MACD?

Moving Average Convergence Divergence (MACD) isn’t really as complicated as its full name if you break it down.

MACD is a combination of three moving averages and one histogram (the vertical bars) that shows how different the parameters are. However, there are only two lines on the screen:

  1. A blue one – the MACD line is in itself a product of the difference between a longer moving average and a shorter one (for instance, a 12-day and a 26-day). The resulting MACD line is a theoretically more accurate trend indicator.
  2. A red one – the signal line, which is an even shorter 9-day (most of the time) moving average.

Since the averages indicate how the average price changed for each day for a specific asset in question, the longer lines indicate a longer trend, and the shorter lines indicate a shorter trend.

MACD’s (the indicator, not the line) job is to show how a recent trend changes in relation to the long ongoing market situation. That’s what oscillators do, they help you compare results. Sometimes the indicators can collect information for as long as 200 days, but that’s for long-term investment. MACD is working with much smaller periods.

How exactly does it work?

To understand how it works, you should first understand how to read everything MACD shows you.

First of all, both lines waver around a zero line. A zero line is supposed to represent an average for the averages. It’s not moving, it just shows where the prices stop the most. In simple words, the trends get stronger the farther away indicators are from it.

So, if the MACD line is:

  • Above the zero line – the trend is currently bullish (upward)
  • Below the zero line – the trend is currently bearish (downward)

The direction of this line should tell you where the general trend is going. If the line is going towards zero, then the price is leaving the extremes, and vice versa. Similarly, the angle of the line should tell exactly how strongly the trend is developing. But you could read this on the standard graph – the MACD is just much cleaner.

Anyway, the MACD indicator has another line, the purpose of which is to show you an even fresher trend.

If the signal line is:

  • Above the blue line – it’s time to buy
  • Below the blue line – it’s time to sell.

The logic is the same as with the previous pair. For instance, if the red line crossed the blue line from beneath, then some very recent changes have started to turn the trend upwards, even if the indicator that works with the larger periods of time (MACD) didn’t register it yet.

There is also a histogram (the bar section that hugs the zero line directly). Its purpose is to show the difference between the two lines. If the MACD line is on top, the bars are facing upwards. If the signal line is on top, the bars are facing downwards.

The histogram shouldn’t be underestimated even though the indicator is very often at the very bottom of your screen because just by looking at the size and coloring of the recent bars you can read the trend.

How to use MACD?

MACD is a personal and customizable indicator. A lot of brokers have it built-in right inside of their trading platforms, and you can often change settings. The most highly customizable parameter is by far the length of the indicators.

The 12, 26 and 9 periods are standard, but you can change them if you feel other moving averages better fit your trading approach.

Changing the parameters to larger periods will increase the time range, making it more suitable for longer-term investments. Still, it’s recommended not to wander too far away from the recent data because this oscillator has been created to register the difference between the short term and even shorter term data in a very sensible way.

It’s also best not to change the proportions in which the parameters of averages are at their standard settings, especially if you don’t know how to use MACD.

In the end, the best combination would still be the standard period range because MACD is very efficient at indicating the sensible recent trend changes in a very clean manner.

The limitations

MACD excels at reading small changes during a very short period of time. It’s achieved by comparing an accurate MACD line to a sensitive signal line that collects the information over the course of 9 days.

As a result, it’s very efficient short-term, especially in conjunction with other tools that improve the experience of short-term investors, like the signal providers (not to confuse with the signal line inside this indicator).

For instance, a signal appears that the stock price can rise in the coming days. Simultaneously, the red signal line crosses the blue MACD line from beneath, which implies a sharp upward shift. Two facts match – the trend is going to rise.

Naturally, MACD shouldn’t be used as an ultimate indicator. Traders generally use it to confirm or dispel their suspicions, which ultimately helps make a decision.

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