This series of guides to technical indicators will equip beginners with the right tools for technical analysis, starting with Moving Average Convergence Divergence (MACD) and how you can start using it; This guide explains what is Moving Average Convergence Divergence.
What is Moving Average Convergence Divergence (MACD)
Moving Averages Convergence Divergence – or MACD, in short – is a momentum indicator that gauges a cryptocurrency’s overall trend, through the display of two moving averages of prices. It is one of the simplest and most effective technical indicators that you can use to measure where prices are headed.
Here’s how it is used together with the price of a cryptocurrency, in this case, Bitcoin (BTC):
What is a Moving Average?
Moving averages are used in technical analysis as it smoothens out past prices and defines its current direction. The 2 most commonly used moving averages are as follows:
- Simple Moving Average: A simple average is calculated by calculating the average price of a cryptocurrency over a specific time period. Therefore, a 7-day simple moving average is the sum of a cryptocurrency’s prices over a span of 7 days and divide it by 7.
- Exponential Moving Average (EMA): EMA is similar to a simple average but emphasizes more on the latest data. More weight is given to the latest price data is it is more relevant and indicative of the current market trend. MACD uses exponential moving averages.
Components of MACD
There are 3 main components of the MACD that you should know:
- MACD Line (Blue): The MACD line is a combination of 2 EMA; it is the difference between the 26-day and 12-day exponential moving average of closing prices. It is important to note that 26-days and 12-days are the default numbers for MACD; you can change the number around if you feel confident in using and interpreting different time intervals.
- Signal Line(Orange): A 9-day EMA, called the “signal” (or “trigger”) line is plotted on top of the MACD to show buy/sell opportunities.
- Histogram: The difference between the MACD Line and Signal Line with the passage of time
How To Trade Using MACD
As its name suggests, MACD is used to explore the points where the MACD line and signal line converges or diverges.
In order to simplify your understanding of how MACD works, we shall focus mainly on the MACD line (blue line) applied in two main scenarios. Here are the two scenarios where you can interpret this indicator to your advantage:
1. Center/Zero Line Crossover
- When MACD line crosses above the Zero Line = BUY
- When it crosses below the Zero Line = SELL
This is the simplest scenario out of the two. Note that in this example, we shall momentarily ignore the signal line (orange line). We shall only focus on the MACD line and the centre/zero-line.
The MACD line would often oscillate between the centre line, which is fixated at point 0 (black line). A general rule of thumb is that if the MACD line is above the centre line, it is a positive signal. This occurs when the 12-day EMA is higher than the 26-day EMA (since the MACD line is made up of the difference between the 26-day and 12-day EMA). In the example above, the green highlighted area is when the MACD line is above the centre line, and you can generally see that prices would tend to move upwards.
The reason why it’s a positive signal when the 12-day EMA is higher than the 26-day EMA (and therefore, above the zero-line) is because recent prices (in the last 12 days) shows a greater upward momentum as compared to the 26-day average, and since EMA takes higher weightage of more recent prices, it will mean that prices would tend to move higher than before!
When the MACD line is below the centre/zero-line, it means that it is a negative signal. From the example above, we can see that when the MACD drops below the centre line – as highlighted in red – prices tend to move further downwards. This is a sign of bad times.
The reason why it’s a negative signal is that the 12-day EMA is lower than the 26-day EMA (and therefore, below the zero-line). This indicates that recent prices (in the last 12 days) shows a greater downward momentum as compared to the 26-day average, and since EMA takes higher weightage of more recent prices, it will mean that prices would tend to move lower than before! Ouch.
2. Signal Line Crossover
- When MACD line crosses above the Signal Line = BUY
- When it crosses below the Signal Line = SELL
In this scenario, the signal line (in orange) comes into play and is very relevant.
A bullish crossover is a positive signal which occurs when the MACD line (in blue) crosses over the signal line in an upward fashion. This means that the MACD line is higher than the signal line. We can see from the above example that on November 15 (highlighted in gree), there was a bullish crossover that led to the strong rally upwards, and prices were soaring high.
A bearish crossover is a negative signal which occurs when the MACD line (in blue) crosses below the signal line. This means that the MACD line is lower than the signal line. From the example, we can see that there were 2 bearish crossovers (highlighted in red) that led to prices crashing down.
*For the purpose of illustration, the charts used in this guide uses daily (1-day) candlesticks. It is up to you to choose which time interval (daily, weekly, monthly or even hourly or minute candlesticks) is suitable for you!
Using MACD in Tradingview
Tradingview is perhaps one of the best free charting platforms that you can use for performing technical analysis. However, each user can only use a maximum of 3 technical indicators if you’re using a free account. You can start adding technical indicators to your chart through following these steps: