Moving Average Convergence Divergence, also called MACD, is a trend-following momentum indicator widely used by traders. Although the MACD is a lagging indicator, it can be very helpful in identifying potential trend reversals.
The MACD oscillates above and below a zero line, also known as the center line. The shorter moving average is subtracted from a longer moving average to arrive at the MACD value. A signal line, which is the exponential moving average of the MACD, completes the indicator.
The blue line is the MACD and the red line is the signal line. When the blue line crosses above the red line, it is a signal to buy and when the blue line falls below the red line, it is a trigger to sell. A cross above the center line is also a buy signal.
Let’s take a look at how to use the indicator to get better entries and exits from a variety of positions. Next, we will investigate how the MACD parses during pullbacks and in an uptrend. Finally, we will briefly look at the importance of divergences in the MACD.
Adapting the indicator to the volatility of the cryptocurrency market
Compared to legacy markets, cryptocurrencies are witnessing big moves in a short time. Therefore, the entrances and exits must be fast to capture a large part of the movement, but without too many exchanges.
When a new uptrend begins, it generally remains in effect for a few weeks or months. However, each bullish phase has its share of corrections. Traders should aim to stay with the trend and not be stopped by every minor pullback along the way.
The goal should be to enter the position early when the new uptrend starts and to stay in the position until a trend reversal is indicated. However, this is easier said than done. If the indicator gives too many signals, there will be various unwanted trades that will incur large commissions and will be emotionally draining.
On the other hand, if time frames are chosen to give fewer signals, a large part of the trend could be lost, as it will take time for the indicator to identify reversals.
This issue was addressed by MACD creator Gerald Appel in his book Technical Analysis: Power Tools for Active Inverters.
Appel highlights how two MACD indicators can be used during strong trends, the most sensitive is used for entries and the least sensitive for exits.
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Are two MACDs better than one?
The default value used for the MACD indicator by most charting programs is the combination of 12 to 26 days. However, for the following examples, let’s use a MACD with the combination of 19 to 39 days, which is less sensitive and will be used to generate sell signals. The second will be more sensitive, using the 6-19 day MACD combination that will be used for buy signals.
Bitcoin (BTC) was trading in a small range in September 2020 and during that period, both MACD indicators were largely flat. In October, when the BTC / USDT pair started an uptrend, the MACD gave a buy signal when the indicator crossed above the center line in mid-October 2020.
After entering the trade, watch as the MACD approached the signal line four times (marked as ellipsis on the chart) on the sensitive 6-19 day MACD combination. This could have resulted in an early exit, leaving a large chunk of the gains on the table as the uptrend was just beginning.
On the other hand, notice how the less sensitive 19-39 day combination held steady during the uptrend. This could have made it easier for the trader to stay in the trade until the MACD fell below the signal line on November 26, 2020, triggering a sell signal.
In another example, Binance Coin (BNB) crossed the center line on July 7, 2020, prompting a buy signal. However, the sensitive MACD turned down quickly and fell below the signal line on July 6, as the BNB / USDT pair entered a small correction.
Comparatively, the less sensitive MACD remained above the signal line until August 12, 2020, capturing a larger portion of the trend.
Traders who are having difficulty keeping track of two MACD indicators can also use the default combination of 12-26 days. Litecoin’s (LTC) trip from roughly $ 75 to $ 413.49 generated five buy and sell signals. All trades generated good entry (marked as ellipses) and exit (marked with arrows) signals.
Related: 3 Ways Traders Use Moving Averages To Read Market Momentum
How the MACD can signal corrections
Traders can also use the MACD to buy pullbacks. During corrections in an uptrend, the MACD falls to the signal line, but as the price resumes its uptrend, the MACD bounces off the signal line. This hook-like formation can provide a good entry opportunity.
In the example above, Cardano (ADA) crossed the center line on January 8, 2020, indicating a buy. However, when the bullish movement stalled, the MACD fell close to the signal line on January 26, 2020, but did not break below it. When the price rallied, the MACD broke away from the signal line and resumed its bullish move.
This provided an opportunity for traders who may have missed buying the cross above the center line. The sell signal was generated on February 16 just as the ADA / USDT pair was beginning a deep correction.
MACD divergences can also indicate a trend reversal
The price of Bitcoin continued to hit higher highs between February 21, 2021 and April 14, but the MACD indicator recorded lower highs during the period, forming a bearish divergence. This was a sign that momentum was weakening.
Traders should be cautious when a bearish divergence forms and avoid taking long trades during that period. The long bearish divergence in this case culminated in a massive drop.
Litecoin shows how the MACD formed a bullish divergence during a strong downtrend from July to December 2019. Traders who bought the cross above the center line may have been hit in September and again in November.
This shows that traders should wait for price action to show signs of trend reversal before acting on MACD divergences.
Some important conclusions
The MACD indicator captures the trend and can also be used to measure the momentum of an asset. Depending on market conditions and the asset being analyzed, traders may vary the MACD period setting. If a currency is moving quickly, a more sensitive MACD could be used. With slow engines, the default settings or a less sensitive MACD can be used. Traders can also use a combination of a less sensitive and more sensitive MACD indicator for better results.
However, there is no perfect indicator that works all the time. Even with the above permutations and combinations, trades will move contrary to expectations.
Traders should implement money management principles to cut losses quickly and protect paper gains when the trade moves on assumption.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trade move involves risk, you should do your own research when making a decision.