Millions of traders use the MACD indicator to time their entrance and exit points. It’s a favorite among swing traders because it signals when a stock like those is about to shift trends. MACD charts may look complicated, but it’s essentially two lines. When one line crosses over the other, it’s called a signal. Depending on which line crosses which, it’s either a ‘buy’ or a ‘sell’ signal.
How To Read the Chart
MACD inputs vary depending on personal preference, but the fundamentals stay the same. A MACD chart includes three major pieces: Histogram, MACD Line, and Signal Line.
By default, most MACD diagrams are set to 12/26; meaning that they use the difference between the 12-day and 26-day exponential moving averages(EMA) as the MACD line. These inputs are a matter of preference so feel free to modify them to fit your needs. Personally, I like to use a 15/30 MACD because it smoothes out the chart and reduces false signals.
The 9-day EMA is usually used as the signal line, and the MACD histogram represents the difference between the two lines; in other words, the ‘convergence‘ or ‘divergence‘ of them.
That’s how we get the term Moving Average Convergence/Divergence. See? It’s less complicated than it sounds!
As share prices change, MACD fluctuates above and below the signal line. When the MACD crosses above the signal line, it’s considered a buy signal. When it goes below, its an indicator that prices could decline.
MACD can help you trade stocks more effectively because it can tell you when an uptrend is running out of steam. It can also be used to determine if a downward-trending stock has bottomed.
Always ensure the MACD line has truly crossed over before making a call. MACD commonly tricks traders by running along the signal line and pulling back at the last minute without a crossover. If you’re going to use MACD to trade, be patient and don’t jump the gun.
Rapid Rises/Falls in MACD
Traders also use MACD to measure momentum in stocks. When MACD makes a drastic upward or downward movement, it’s a signal that the stock could be overbought or oversold. This technique is especially powerful when used in conjunction with the Relative Strength Indicator (RSI).
MACD Stocks: Histogram
You can also use the MACD histogram to analyze your trades. The histogram provides all the relevant information you need to strategize your trades. However, there are timing differences between the histogram and the MACD signals so it takes some experience. MACD crossovers, rapid rises & falls, and divergence can all be gauged by examining the histogram.
Limitations of MACD for Stocks
MACD isn’t a perfect indicator because, if it was, we’d all be rich. Since MACD is a ‘trailing indicator’ it lags behind the actual price trends. By the time MACD shows a sell or buy signal, there’s a strong possibility you may have already missed the boat. Plus, false signals and fakeouts are also common, so be patient and disciplined when you use this indicator.
I prefer using MACD in conjunction with other oscillators and signals. I like to look for three confirmation signals before jumping in a trade. For example, if MACD is showing a bullish signal, check out some other indicators, like RSI or OBV, to see if they’re also showing positive signals. By double-checking your analysis with multiple signals, you reduce the chances of falling victim to a fake-out.
MACD Final Word
MACD is one of the most commonly used indicators because it’s easy to read and understand, but it’s not an end-all solution. Indicators like MACD are not perfect, so don’t rely solely on MACD to make your trades or else your portfolio will suffer. MACD is best used as a confirmation indicator, so always second guess it with common sense and patience.
Test it out for yourself. Indicators are largely a matter of personal preference, so try it out and see if you like it. If you don’t, there are tons of other indicators that you can choose from.
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