How to Use Moving Average Convergence Divergence (MACD) for Better Trading

The Moving Average Convergence Divergence (MACD) is the go-to indicator for most traders. It’s flexible, easy to use, and helpful for spotting the best times to enter and exit positions.

This guide breaks down all things MACD – from its basics to practical tips for making smarter trades. Read on to learn everything there is about this popular indicator.

What is Moving Average Convergence Divergence?

The MACD is a trend-following momentum indicator. It tracks the correlation between two moving averages, usually the 12-day- and 26-day. MACD is primarily used to spot changes in market direction and potential entry/exit points. It’s plotted as an oscillator at the bottom of the respective asset’s price chart.

The Moving Average Convergence Divergence consists of three parts:

The MACD Line

This is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. It shows the relationship between the asset’s short-term and long-term momentum.

Whenever the 12-day EMA is above the 26-EMA, the MACD line will be above the baseline. On the contrary, when the 12-day EMA moves below the 12-day EMA, the MACD line goes below the baseline.

The Signal Line

This line provides crossovers with the MACD line to produce entry and exit triggers.

The Histogram 

This moves above and below the baseline, showing strength and weakness in price.

• When the MACD line moves past the signal line, the Histogram appears in green bars.
• This suggests that the price is in an uptrend.
• The Histogram turns red when the MACD line is below the signal.

The MACD indicator can be applied to any timeframe, from one minute to monthly. This makes it useful for all traders, whether they’re engaged in day, swing, or position trading. Not to mention long-term buy-and-hold investors.

How to Read the Moving Average Convergence Divergence  Indicator

Now, let’s explore how to use the MACD indicator in different market conditions.

The Histogram 

With the Histogram, there are two different things to consider – the slope and the shape. During a strong price trend, the gap between the MACD and the signal lines widens – resulting in an expanding Histogram.

An expanding Histogram signals growing momentum. When this happens, traders can look for entry points in the trend direction. As the momentum weakens, the Hologram shrinks. This indicates that the price might reverse or remain sideways. In this instance, it’s best to close existing trades and wait for the trend to regain momentum.

So, how to decide entry points based on Histogram?

• The key is to look for two or more expanding Histogram bars forming at the beginning of a trend.
• For instance, if two or more green bars are forming – this could be the signal to enter a long position. Then, when the Histogram decreases in size, it’s time to exit the trade.

In a downtrend, you will see expanding red Histogram bars below the baseline. This shows that sellers have entered the market and are moving it with a heavy momentum. Therefore, it might be wise to short the asset. As the buying pressure comes in, the red bars shrink – indicating that the downward trend is losing momentum.

Crossovers 

Many traders use MACD crossovers to find signs for reversals. These happen when the MACD line intersects the signal line. Put otherwise, it’s a sign that a possible trend reversal is coming.

• Bullish Crossover – If the MACD line moves past the signal line, the uptrend momentum usually increases. Traders could consider it a sign to enter a long position.
• Bearish Crossover – This happens when the MACD line drops below the signal line, hinting at downward momentum and a potential price decline. This prompts traders to sell or consider short positions.

While MACD crossovers can provide early signs of trend reversals, they could also be false signals. As such, you can’t consider them in isolation. This is where the baseline crossovers come in.

Baseline Crossovers and Pullbacks

The Moving Average Convergence Divergence has a zero line (also called the baseline) – which is the midpoint of the indicator.

• When the 12-day EMA meets below the 26-day EMA, the MACD line moves below the zero line. This suggests that momentum has turned bearish, pointing to the likelihood of a new downtrend trend forming.
• Likewise, when the 12-day EMA crosses above the 26-day EMA, the MACD line moves above the baseline. This implies that momentum has turned bullish, and an uptrend may be starting.

You can combine this with the baseline pullbacks for more confirmation. For instance, during strong trends, the MACD line might pull back to the baseline. This indicates a strong entry point before the price bounces back.

However, bear in mind that not all pullbacks signal a buying opportunity. Instead, you should also wait for the MACD line to cross above the signal line. Additionally, also consider whether the Histogram is green and how strong the trend is.

The reverse indications can be used to enter a short position. That is, the MACD line should pull back to the baseline from below – along with red Hologram bars.

Divergence 

MACD divergences can also be signs of reversals, which can help you find potential trend changes. It occurs when the asset price and the MACD indicator give different outputs. Traders use the Histogram to figure out the respective divergences.

A bullish divergence appears when the price makes lower lows, but the MACD creates higher lows. This demonstrates that the momentum is decreasing, and the price will likely pause or reverse.

On the contrary, a bearish divergence ensues when the price forms a higher high while the MACD constructs a lower high. This shows that the uptrend momentum is decreasing, and the price will likely stall or reverse.

Potential Pitfalls of Moving Average Convergence Divergence

While the MACD is a powerful tool, it does have limitations. Traders need to recognize these shortcomings and adjust their strategy accordingly.

False Signals in Sideways Markets

Perhaps the main challenge when using MACD is its tendency to produce false signals – especially in a range-bound market. In these conditions, it may frequently cross above and below the signal line without any meaningful trend developing. This leads to buy or sell signals that go against the market outcome.

Put otherwise, these false signals often arise because the MACD is a trend-following indicator. In sideways markets, it can struggle to differentiate between short-term fluctuations and a genuine trend shift. To avoid false signals, getting confirmation from other indicators is advisable (more on that below).

Dependent on Historical Data

As with other technical indicators, the MACD uses historical data. This can provide insights, but it doesn’t guarantee precise market predictions.

As such, signals may arise after a trend has already begun. This may lead traders to enter positions late. Or miss the opportunity entirely. Therefore, traders should combine the MACD with a leading indicator to avoid delays in trend shifts.

Combining Moving Average Convergence Divergence With Other Indicators

It’s best to use multiple technical indicators to double-check analysis findings. Below, we discuss which tools work well with the MACD.

Relative Strength Index (RSI)

Traders often pair Moving Average Convergence Divergence with the RSI to confirm signals. The latter specializes in finding overbought or oversold conditions.

For instance, when the MACD shows a bullish crossover and the RSI is below 30, it confirms an oversold market. This strengthens a buy signal, as a trend reversal could be imminent.

Conversely, if the MACD shows a bearish crossover and the RSI is above 70, it confirms an overbought condition, suggesting a strong sell signal.

Either way, combining the MACD with the RSI strengthens the trade’s reliability.

Moving Averages (MA)

Moving averages help identify a trend direction by removing the noise of small price fluctuations. You can choose different time frames for MAs – such as 10-day, 50-day, and 200-day.

Here’s how to use the MA with the MACD:

• When the MACD line crosses above the signal line and the price is above the 50-day moving average, the uptrend is likely strong.
• For a sell signal, a bearish MACD crossover below a long-term moving average confirms downward momentum.

Volume Indicators

Volume indicators, such as On-Balance Volume (OBV) or the Volume Oscillator, show the strength of buying or selling activity. A bullish MACD crossover with rising volume reinforces a buy signal.

On the other hand, a bearish crossover with high selling volume confirms a sell signal. Volume indicators help traders avoid weak signals in low-volume environments.

Bollinger Bands

Bollinger Bands estimates price volatility and can also help identify price reversals or breakout points.

• The best strategy is to look for MACD signals a bullish crossover near the lower Bollinger Band. This may indicate a price bounce for long traders.
• A bearish crossover near the upper band could suggest a reversal or pullback. This means traders should exit a long position. Or, short the asset to capitalize on the expected decline.

Bollinger Bands add a layer of volatility analysis to MACD signals. This means traders can better time entries and exits in volatile markets.

Consider Price Action 

The asset price itself is the most reliable tool. The MACD simply interprets the data. So, it’s also wise to let price action guide you when using this indicator. For instance, when price movement is weaker than before or goes sideways, you’ll likely see divergence on the MACD. This doesn’t necessarily indicate a reversal.

Therefore, look for divergence when the price goes down. Similarly, if the price action breaks a trend, consider acting on it – even if there’s no MACD divergence. Prioritize what price action is showing you directly. Having said that, mastering price action trading takes time and practice – so beginners must be dedicated to achieve good results.

How to Manage Risks With the Moving Average Convergence Divergence

Here are some strategies to effectively manage risk while using the MACD:

Test Your Strategy Before Risking Money 

If you’re new to trading, it will take time to understand indicators. Before diving in, it’s best to test your MACD strategy in a demo account. This can be accessed via your brokerage.

Demo accounts come with paper money – which you can use to place orders in a live market. Based on the results, you can adjust your MACD parameters or combine it with different indicators

Set Stop-Loss Orders

Placing stop-loss orders ensures that losses are capped if the trade goes against your expectations.

Here’s an approach to consider:

• For buy signals (MACD line crosses above the signal line), set a stop-loss just below a recent support level.
• For sell signals, place it slightly above recent resistance levels.

You can also use trailing stop losses to adjust the levels based on price action.

Adapt MACD Settings to Market Conditions

Moving Average Convergence Divergence comes with default settings such as 26-day and 12-day EMAs. However, you can change this as per market conditions.

In high-volatility markets, consider using longer periods (e.g., 15-day and 30-day EMAs) to reduce noise. On the other hand, shorter periods (e.g., 8-day and 20-day) may capture signals more promptly for stable trends.

Limit Position Size

By managing position sizes, traders can reduce potential losses on any single trade. The common approach is to risk only a fixed percentage of the total funds (usually 1 to 3%).

Conclusion

Mastering the Moving Average Convergence Divergence can help fine-tune your trading strategies.
Its ability to highlight trend shifts and momentum makes it a valuable part of any trading toolkit.

However, relying solely on MACD can be overwhelming and lead to inconsistency. As such, considering price action and other indicators, such as volume and momentum, is necessary.

This optimized approach helps confirm signals, reduce false entries, and build a more reliable trading strategy.

FAQs

How reliable is the MACD indicator?

Moving Average Convergence Divergence is generally reliable for identifying trends and potential reversals. However, it’s most helpful in trending markets and might produce false signals in sideways or volatile conditions.

Can I use MACD for scalping?

Yes, MACD is widely used by scalpers with 1-minute, 5-minute, or 15-minute charts. It’s also best to adjust the MACD settings to shorter periods – like 6, 13, and 5 instead of the default 12, 26, and 9.

Which time frame should I use for MACD?

The best time frame for the MACD depends on the strategy. Longer time frames tend to reduce noise and increase reliability, especially for swing or position trading.

What are the weaknesses of MACD?

MACD can produce false signals in sideways markets and is limited by its reliance on historical data. It also tends to lag, meaning entry and exit signals might occur after a trend change has started.

Which indicators should be used with MACD?

MACD works well with the RSI to confirm overbought and oversold conditions, and with moving averages for trend verification. Volume indicators, like OBV, can also add context by showing the strength behind price moves.