The MACD or Moving Average Convergence Divergence is a tool used by traders to determine the direction of the trend, potential reversals, and momentum in trading. We can calculate the MACD as follows:
MACD Line = 12-day EMA – 26-day EMA
Signal Line = 9-day EMA of MACD Line
We can use the MACD in three different ways
The moves you can see across the zero line on the indicator indicate the period when the 12-day EMA crosses the 26-day EMA.
A new uptrend may emerge if the MACD crosses the zero line from below. On the other hand, a new downtrend may emerge if the MACD crosses the zero line from above.
Signal Line Crossovers
This movement offers a better timing and is mostly preferred by traders over zero-line crossovers. It shows a buy signal when the MACD crosses above the Signal Line. The sell signal appears if the MACD line crosses below the Signal Line.
Take note that the MACD is just an indicator and does not function as a trading system, which means there is no stop loss.
If the buy signal is shown, a stop should be placed below the recent low while the sell signals indicate that a stop should be placed over the recent high.
The strategy for this one is to take trades in the direction indicating a long-term trend to prevent the whipsaw trades. You must only take the buy signals if the trend is up and you must exit if it crosses below.
This strategy has two types,
bearish divergence occurs when the price makes new highs while the MACD is consistent. The momentum appears slow and a possible reversal is forthcoming.
Bullish divergence, on the other hand, indicates that the price makes new lows, while the MACD is consistent. The selling pressure slows and the reversal higher is anywhere around the corner.
You can make the MACD more useful if you combine these elements and their strategies. By making use of the trend analysis and price movements, you can determine whether you are going to take the buy or sell signals.