What is MACD? A Detailed Guide to Trading Strategies for Beginners

Introduction to MACD Indicator

MACD is a technical indicator developed by Gerald Appel in 1979 and has become one of the most important analysis tools in the financial markets. From forex trading, cryptocurrencies to stocks, MACD is widely used by investors to identify price trends and seek profitable trading opportunities.

What is MACD? How to Build the Formula

MACD stands for Moving Average Convergence Divergence. It is calculated based on the difference between two exponential moving averages (EMA) with periods of 12 and 26, with the basic formula:

MACD = EMA(12) – EMA(26)

When the EMA(12) (is represented in red) and is above the EMA(26) (which is blue), the MACD value will be positive. Conversely, when EMA(12) is below EMA(26), MACD takes a negative value. The greater the distance between the MACD line and the zero (baseline), the clearer the divergence between the two moving averages.

Main Components of the MACD Indicator

A complete MACD indicator includes four key elements:

Main MACD Line - Helps investors monitor and determine the market trend direction in each phase.

Signal Line (Signal Line) - Calculated from EMA(9) of the MACD line itself (not EMA(9) of the price). When MACD and Signal Line cross, they generate important reversal signals.

Histogram - Shows the difference between the MACD line and the Signal Line, clearly reflecting the convergence or divergence of these two lines.

Zero Line (Zero Line) - Acts as a reference line to help traders assess the strength of the trend, thereby identifying whether the current trend is strong or weak.

Key Signals from MACD

The MACD indicator provides three main trading signals:

Crossovers Between MACD and Signal Line

When the MACD line crosses above the Signal Line, and the Histogram shifts from negative to positive, this is a buy signal indicating an upward price trend.

Conversely, when MACD crosses below the Signal Line and the Histogram shifts from positive to negative, this is a sell signal warning that the price may decline.

MACD Crossing Zero

When the MACD line crosses above zero from below (MACD turns positive), it means the short-term EMA(12) has crossed above the long-term EMA(26), generating a bullish signal.

Conversely, when MACD crosses zero from above, turning negative, it indicates the short-term EMA has weakened relative to the long-term EMA, signaling a bearish market.

Divergence and Convergence

Divergence (Divergence) occurs when the price makes new highs but the MACD fails to follow and even starts to decline. This is a strong warning that buying momentum is weakening and the price may reverse from uptrend to downtrend. For example, Bitcoin experienced a sharp decline from around $68,000 shortly after divergence was formed.

Convergence (Convergence) occurs when the price is falling but the MACD begins to rise and trend towards convergence. This signals that selling pressure is easing and the price may reverse upward, presenting a good opportunity for investors to consider buying.

Trading Strategies with MACD

Basic Signals

Based on the three main signals of MACD, traders can develop strategies such as:

Buy when:

• Histogram shifts from negative to positive
• MACD crosses zero from below
• Convergence appears

Sell when:

• Histogram shifts from positive to negative
• MACD crosses zero from above
• Divergence appears

Combining MACD with Stochastic Oscillator

The Stochastic Oscillator measures price momentum by comparing the closing price to the price range over a specific period. This indicator ranges from 0 to 100 and includes two lines: %K (main line) and %D (moving average).

When the Stochastic exceeds 80, the market is in an overbought state and likely to reverse. When it drops below 20, the market is oversold and may recover.

The Double Cross Strategy combines both MACD and Stochastic, waiting for both indicators to generate crossover signals simultaneously. This helps to more accurately identify trend reversals and reduce false signals.

Combining MACD with RSI (Relative Strength Index)

RSI is also a momentum indicator, calculated by dividing the average gains by the average losses over a certain period (usually 14 periods). RSI helps identify overbought and oversold zones:

• Overbought zone starts at 70 points (some traders use 75 or 80 during strong bullish markets)
• Oversold zone when RSI drops below 30 (some wait for 20 or 25 for safety)

MACD and RSI complement each other: RSI helps recognize overbought/oversold regions, while MACD determines trend direction and entry points. When RSI is in the overbought zone and MACD crosses Signal downward, the sell signal becomes very strong.

Limitations of the MACD Indicator

Although MACD is a popular and effective tool, it has some weaknesses to note:

• False signals: Divergence and convergence are not always accurate, sometimes generating false signals leading to losses.

• Subjectivity: Each trader can set different MACD parameters according to their goals, so results depend on subjective choices and may be less accurate than actual market movements.

• Lag (Delay): Because MACD uses moving averages, it tends to react slower than real market changes, resulting in delayed trading signals.

Frequently Asked Questions

How to reduce false signals?

A effective method is to use multi-timeframe analysis. Traders can use higher timeframes to identify the main trend, then switch to lower timeframes to find potential trading signals.

What settings should be used for MACD?

Although the default settings are 12, 26, 9, you can adjust to longer periods like 21, 55, 9 for more consistent and stable signals.

Conclusion

MACD is a complex indicator with some limitations, but its importance in technical analysis is undeniable. Any trader should master how to use MACD to predict price trends and find entry/exit points. Currently, MACD is available on most trading platforms. The key is to practice regularly, combine MACD with other indicators, and manage risks carefully to succeed in trading.