Moving Average Convergence Divergence

Whether you're a crypto enthusiast looking to enhance your trading skills or a seasoned pro aiming to refine your strategy, incorporating Moving Average Convergence Divergence (MACD) into your toolkit is a step in the right direction.

At Altrady, we've helped thousands of crypto traders use the MACD indicator to identify profitable trading opportunities. This guide provides a comprehensive overview of the MACD, with practical examples and insights for the cryptocurrency market

What is the Moving Average Convergence Divergence (MACD) Indicator?

The Moving Average Convergence Divergence (MACD) is a momentum oscillator that provides a more in-depth view of market trends, helping traders recognize potential trends, reversals, and buy or sell signals.

MACD shows the relationship between two moving averages of a security's price and has three components:

MACD Line

The MACD line reflects the relationship between long-term and short-term price fluctuations as a result of calculating the difference between the 12-period and 26-period EMA, where the shortest period performs a faster reaction. 

The relevancy of this line boils down to representing market momentum as the 12-period EMA pulls away from the 26-period: 

• A rising MACD implies bullish momentum
• A falling MACD means bearish momentum.

Signal Line

This signal line reacts slowly since it derives from calculating the MACD line into a 9-period EMA. This way it serves the MACD line as a reference to interpret crossovers.

Essentially, the signal line triggers signals on bullish and selling opportunities following the interaction with the MACD line, meaning a shift in momentum: 

• A crossover by the MACD line above the signal line indicates a shift in momentum from bearish to bullish.
• Conversely, the crossover below suggests a shift in momentum from bullish bearish to bullish.

It is elementary to understand the role of the zero line when spotting crossovers. Consider the following:

• When the MACD line crosses above the signal line while both are below zero, it is called a golden cross.
• When the MACD line crosses below the signal line while both are above zero, it is called a death cross.

Histogram

How the histogram is calculated (difference between MACD line and signal line).

The histogram calculates the subtraction of the signal line value from the MACD line to represent it in the form of green and red bars.

A widening histogram indicates increasing momentum when:

• Bars are getting taller above the zero line, which also indicates momentum is accelerating.
• Bars are falling and getting taller below the zero line, which also indicates momentum is accelerating.

A narrowing histogram indicates decreasing momentum, even if the trend is still in place, when:

• Bars are getting shorter, even if the MACD line is still above or below the zero line.
• The histogram is narrowing, indicating that the momentum of that trend is weakening.

The above may be a sign of a potential trend reversal. The histogram serves to anticipate crossovers before they happen:

• Bearish crossover: If the histogram is narrowing and approaching the zero line from above, it suggests that the MACD line is likely to cross below the signal line soon.
• Bullish crossover: If the histogram is narrowing and approaching the zero line from below, it anticipates a potential cross above the signal line.

Interpreting Zero Line

The zero line represents a point where the 12-period and 26-period EMAs are equal. It provides a reference for interpreting the MACD.

To interpret the MACD relative to the zero line cross, consider the following:

• MACD line above zero: Indicates that the 12-period EMA is above the 26-period EMA, suggesting a bullish condition.
• MACD line below zero: Indicates that the 12-period EMA is below the 26-period EMA, suggesting a bearish scenario.
• Zero Line Crossover: When the MACD moves above the zero line is considered bullish, while a move below the zero line is bearish.

How Does the MACD Indicator Work?

The MACD is calculated by comparing two different 'speeds' of moving averages:

• The faster moving average (12-period EMA) reacts more quickly to price changes,
• The slower moving average (26-period EMA) lags behind.
• MACD = 12-Period EMA − 26-Period EMA

The difference between these two averages reveals the momentum of the price trend. The result is known as the MACD line. 

Additionally, a 9-period EMA of the MACD line is plotted as the signal line.

The MACD is best used with daily periods, where the traditional settings of 26/12/9 days are recommended.

How to Interpret MACD Signals

The most common interpretations of the MACD values are:

• A positive MACD indicates that the 12-period EMA is above the 26-period EMA, which means that the price is in an uptrend.
• A negative MACD indicates that the 12-period EMA is below the 26-period EMA, which means that the price is in a downtrend.

MACD Practical Applications in Trading Crypto Assets

Here are MACD’s practical applications in the world of crypto trading:

Identify trend reversals

One of the primary uses of the MACD indicator is to identify potential trend reversals, which traders use to enter or exit positions. 

When the MACD line crosses above the signal line, it generates a bullish signal, indicating a potential upward trend (buying opportunity). 

Conversely, when the MACD line crosses below the signal line, it generates a bearish signal, suggesting a possible downward trend (time to sell). 

Traders often use these crossover points to enter or exit positions.

Confirm trends

Traders can rely on the MACD indicator to confirm the strength of an existing trend. 

When the MACD line diverges from the price chart, it suggests a weakening trend, which can serve as a warning sign to traders. 

When the MACD line converges with the price chart, for instance, the line rises sharply, this indicates a strengthening trend, providing traders with confidence in their positions.

Identify overbought and oversold conditions

Overbought and oversold conditions can lead to potential reversals in crypto markets. The MACD histogram is an excellent tool for identifying these conditions. 

When the histogram reaches extremely high levels, it suggests that the cryptocurrency may be overbought, and a correction could be imminent. 

Conversely, when the histogram shows extremely low levels, it’s a sign that the cryptocurrency may be oversold, presenting a potential buying opportunity.

Spot divergence signals

Divergence analysis with the MACD indicator can help traders anticipate trend changes.

A bullish divergence happens when a crypto asset’s price moves in the opposite direction of the MACD indicator. This signal can reveal a potential trend reversal.

For example, if the Ethereum price shows a lower low and the MACD doesn’t show the same, this is a typical situation of a MACD bearish divergence. 

It means the downward trend can soon end and there’s a high chance for a reversal.

Using MACD in Combination with Other Technical Indicators

MACD and Relative Strength Index (RSI)

Combining MACD and RSI is a common technique to confirm or reject divergence signals. For instance, if both the MACD and the RSI show a bullish divergence, this increases the probability of a bullish reversal. Instead, if the MACD and the RSI show conflicting signals like one shows divergence and the other doesn’t, you can’t reach a clear conclusion regarding your trading decision.

MACD and Bollinger Bands

Crypto traders and investors can use the MACD and Bollinger Bands together to confirm or reject breakout and overbought/oversold signals.

For example, if both the MACD and Bollinger Bands indicate a breakout to the upside, the bullish trend will likely continue.

But if both indicators show an overbought condition, this suggests a potential pullback or reversal.

MACD and Stochastic Oscillator

Traders can use the MACD and the stochastic oscillator together to confirm or reject crossover

and overbought/oversold signals.

For instance, if both the MACD and the stochastic oscillator show bullish crossovers,

the probability of a bullish continuation increases. But if both indicators show oversold conditions, this implies that a bounce or reversal may be near.

Conclusion

In the world of cryptocurrency trading, mastering the use of the MACD indicator can be a game-changer. It provides valuable insights into potential trend reversals, confirms existing trends, and assists in setting strategic stop-loss and take-profit levels.

You can use the MACD indicator in any time frame and with any security, but it’s mostly recommended for trend-following and momentum strategies.

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