MACD Indicator: Trading with MACD (2024)

A moving average is an average of time series data calculated over a certain number of time periods. As we progress through time, the latest period factors into the calculation, and the earliest period from the previous calculation drops off.

A faster MA is defined as one that is calculated over a smaller number of periods. A slower MA is one calculated over a larger number of periods. Calculated MAs are subsequently plotted on the charts and are usually overlaid on top of the price action.

MAs come in multiple variations, but some may be more relevant than others in understanding the MACD. There are three moving averages:

The prices of all these financial instruments aren’t moving in a straight line, but rather in a jagged ‘up and down’ fashion with a series of sharp peaks and troughs. These fluctuations and oscillations are filtered out by low pass filters. A low-pass filter will pass signal with a frequency that is lower than a selected cutoff frequency and attenuate signals with frequencies higher than this cutoff frequency. MAs present a smoother profile, which allows for ease of analysis and identifying trends.

The MACD formula seeks to harness the benefits of two low-pass filters: a fast EMA and a slow EMA. The standard or "box" setting for the fast EMA is 12 periods, for example, an EMA calculated over 12 periods. The standard or "box" setting for the slow EMA is 26 periods, for example, an EMA calculated over 26 periods.

The MACD can be used in several ways by traders. At a very basic level, it is used to generate buy and/or sell signals using crossovers. When the MACD crosses the signal line from under it and goes over, a buy signal is generated. Such a crossover is often known as the "golden cross". Conversely, when the MACD crosses the signal line from above and goes under it, this generates a sell signal, and is often known as the "death cross". These are also referred to as an MACD bearish crossover​​ or a MACD bullish crossover, depending on which way the price heads.

Read about golden crosses and death crosses​.

The MACD indicator, despite being one of the first indicators to be developed, is still widely used in today’s modern markets due to its effectiveness. One of the core reasons it has remained at the forefront of technical analysis​ portfolios is its ability to predict potential market direction in conjunction with price action.

The way to do this is by using the concepts of divergence and convergence. The MACD is said to be convergent with price action if both prices and the MACD are moving in the same direction. In other words, if prices are making higher highs (in an uptrend) and the MACD makes corresponding higher highs, then we have convergence. Convergence of the MACD with price action confirms the strength, direction, and momentum of a trend. If the MACD moves in the opposite direction, making lower highs as price is making higher highs, then we have negative divergence. Divergence with price action indicates the potential weakening or possible reversal of a trend.

The MACD signal line is the second component of the MACD indicator. It is an EMA of the MACD over a certain number of periods. The standard or "box" setting for this is nine, in other words, an EMA of the MACD calculated over nine periods. It is used to generate buy and sell signals as the MACD line crosses.

As the MACD and MACD signal line are derived from two EMAs, their value will be dependent on the underlying security. As such, it is not possible to compare these values for a group of currencies or across markets such as between the US SPX 500 and an exchange-traded fund​​.

One of the most significant limitations of the MACD is the occurrence of false positives. A reversal is signalled, but never takes place. The opposite can also take place, where a reversal occurs without being signalled. A way to attempt to overcome any of these false signals would be to implement a MACD signal line filter.

Another drawback is that moving averages slightly lag behind real-time prices. This is because it’s an average of the historical prices, so any drastic changes in price would not be seen straight away. Therefore, although the MACD is widely used by traders, it might not be the best technical tool to use in isolation when dealing with volatile price movements. Instead, be sure to use in combination with other technical indicators, such as the average directional index (ADX)​.

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