Moving Average Convergence Divergence Indicator Visual EducationHello Traders,
Today I wanted to go over one of my favorite as well as one of the most widely used tools in trading, the Moving Average Convergence Divergence (MACD) indicator.
This moving average indicator was created invented in 1979 by Gerald Appel responsible for the MACD line and Signal line and later added to this was the histogram, developed by Thomas Aspray in 1986.
Now that you know who created the MACD indicator lets discuss the components of the indicator. The MACD indicator consists of 4 main components, the Signal line , the MACD line , the histogram and the zero line of the histogram often referred to as the baseline.
Below are the calculations of the different components to help you better understand what makes up this indicator.
MACD Indicator Components and Calculations (White Labelling)
Signal Line
Red colored smooth line
The signal line is simply an exponential (weighted) moving average (EMA) based on the prior 26 days closing price.
As with any EMA the formula looks like this: EMA = Closing price x 26 + EMA (previous day) x (1-26)
MACD Line
Blue colored rigid line
The MACD line, similarly to the Signal Line is also an EMA based on the prior 12 day closing price.
Also, similarly to the signal line it uses a similar equation to display the line which is: EMA = Closing price x 12 + EMA (previous day) x (1-12)
Histogram
Green and Red vertical bars charted around a horizontal axis known as the baseline.
The histogram is determined by subtracting the signal line from the MACD line. This is easier to interpret than looking at the two lines alone,
since it is sometimes difficult to tell if one curve is steeper than the other. The histogram is positive when MACD is higher than its nine-day EMA, and negative when it is lower. This oscillator is
definitely a nice touch to the indicator as a whole and my personal favorite indication for divergence which I will teach you more about in part 2 of this series.
Histogram Zero line Aka "Baseline"
This is the line in the center of the histogram oscillator that is also referred to as the baseline. This line is important as you will see later when I explain the signals this indicator creates. This line is calculated by the MACD Line and the Signal line crossing. Which is another way for you to see that the lines are crossing both bullish and bearish crosses.
The calculations behind each part of the indicator is not really information that you need to remember as @TradingView has put a nice suite of house tools for you to use that
calculate this for you but, I find that the more you know the better you are able to understand these charts and who knows, maybe someday this will help you crate your own
indicator using the pine script editor they also make available to us for free. Also, if you understand the math it helps you when editing the settings to adjust indicators better
per the asset you are trading.
MACD Indicator Signals (Yellow and Teal Labelling)
Now lets go over the signals that this indicator produces help with the way you can utilize this indicator to help you trade. A key note to remember is that the MACD indicator is a Moving average
indicator and is best used in a trending market. You can identify a trending market by looking for price action that is heading in one solid direction up or down. Tending markets are usually noted by “higher highs”
and “higher lows” in an uptrend and “lower highs” and “lower lows” in a downtrend . This indicator is best used to help you determine trend reversals. There are also 3 major signal components to this indicator but, in this first series we are only going to discuss 2 as it is important to understand this indicator before moving onto the next step and applying the more advanced features. These 3 major components are MACD line crossing over the Signal line and both signal line and MACD lines crossing over the zero line on the histogram .
MACD Cross (Yellow)
The top MACD line (red rigid line) crossing down over the Signal line (Blue smooth line) is a bearish signal and generally indicates a sell signal letting you know that the price action has potentially came to the end of an uptrend. Again, this is used mainly in trending markets and can be very helpful to assisting in taking profit in a long position or starting a new short position.
In contrast to the bearish MACD cross , you can also see on the bottom of the chart that there is an indication of a bullish cross of the MACD line (Red rigid line) over the Signal line (Blue smooth line). This would be a good indication the the downtrend has ended and it may be a good time to start a long position or close a short position.
The Histogram Zero line cross (Teal)
There are 2 signals you can get from this but the one that matters in my opinion the most is the signal line. So for the sake of explanation I have shown them both together as both bearish and bullish signals on the chart. Now that you know about the signal line and the MACD line it should be easy to identify when these two lines are crossing the zero line of the histogram that we have also discussed. As shown in the chart you can see that the bullish cross is showing the two lines coming from below the Zero Line and crossing above which would be a bullish signal and you would be looking for a buy, potential start of or continuation of an uptrend. On the contrary, if these lines crossed from above the Zero line below then this would be a bearish sell signal and you would be looking to open a short position, be looking for a reversal of an uptrend or continuation of a downtrend.
Now here are some key takeaways and tips you will want to always follow when using this or any other indicator.
#1: Make sure you know the type of market you are trading by analyzing the market structure. Is it trending and creating higher highs and higher lows, lower highs and lower lows? Or is it ranging in almost a rectangular box?
#2: KNOW YOUR INDICATOR and the best market it is used in, again, the MACD Indicator is best used in a trending market!
#3: This is probably the most important of the 3, It is a must that you learn everything about each indicator you are using and to never use ONE indicator/Oscillator for signals stand alone by itself. Trading just like anything else in life is a numbers game and the better statistics you have, the better outcome you will receive.
Congratulations Traders! You now know the basics of the MACD Indicator!!! I hope you will come back for part two and three of this series that I will be releasing after the new year to help some of the new traders entering this ever expanding community here on TradingVeiw!
Part 2: MACD and RSI Divergences Visual Education Release 01/01/2022
Part 3: Falling wedges and Fibs Release 01/02/2022
I hope you had a green year and look forward to learning and trading with all of you winners next year!
Happy New Years,
Savvy
