Technical analysis involves comparing past price movements and using that knowledge to attempt to anticipate and forecast future price changes. What began as a method of studying prices on paper "tapes" and drawing trendlines by hand has evolved into advanced analytical software and a wide range of complex technical indicators.
Among these technical analysis tools is the MACD indicator. It can be used to trigger a buy or sell signal based on market momentum. It can also help a trader identify when a cryptocurrency or other asset is overbought or oversold.
This detailed guide explains what the MACD indicator is, including its definition, how it works, its calculation, and how to use it for crypto trading.
Understanding the MACD Indicator
In short, MACD stands for Moving Average Convergence Divergence. It is a trend-following momentum indicator created by Gerald Appel in the late 1970s to analyze stock prices. However, the MACD indicator can be reliably used in commodities, Forex, and cryptocurrencies.
MACD is a popular technical analysis tool and has, therefore, become a cornerstone of an effective crypto trading strategy. This tool is an unbounded oscillator consisting of a MACD line, a 9-period Exponential Moving Average (EMA) which acts as a signal line, and a histogram.
How Does the MACD Work?
The MACD line is generated by subtracting a long-term EMA from a short-term EMA. The signal line is then plotted on the MACD line. When the two lines converge and diverge, it can indicate that an asset is overbought or oversold, or that the trend may be changing or reversing.
A powerful trading signal can be generated when the two lines cross, indicating that a change in momentum has potentially occurred.
The MACD Calculation Formula
The formula for calculating MACD is as follows:
MACD = 12-period EMA – 26-period EMA
The MACD line is calculated by subtracting the 26-period EMA from the 12-period EMA. Exponential Moving Averages give more weight to recent price data.
The formula for calculating the EMA is:
EMA = Closing Price x multiplier + EMA (previous day) x (1 - multiplier)
According to common technical analysis principles, the MACD has a positive value when the 12-period EMA is above the 26-period EMA. Conversely, it has a negative value when the 12-period EMA is below the 26-period EMA.
The formula for calculating the MACD histogram is:
Histogram = MACD line – Signal line
The difference between these lines is represented visually using the histogram.
MACD Settings for Crypto Trading
There are unfortunately no specific settings to apply to the MACD for crypto markets or other markets, as is the case with Ichimoku and several other technical indicators. Traders are, however, always encouraged to experiment. Be sure to backtest any trading strategy before using your capital to trade.
How to Interpret MACD Signals and Read MACD Charts
With a little practice and some knowledge of the tool, reading MACD charts on cryptocurrency prices can become second nature.
Line crossovers can be used to generate a buy or sell signal. A bullish crossover can be observed when the MACD line crosses above the signal line. Conversely, a bearish crossover occurs when the MACD line crosses below the signal line. MACD crossovers can be a powerful signal to enter a position.
If the MACD line and the signal line are both rising, the momentum is bullish. Conversely, if they are falling, the momentum is bearish. If the lines diverge, it indicates that an asset is overbought or oversold. If the lines converge, it can lead to a crossover.
If the histogram lines are increasing, it means a trend is confirming itself. If the histogram lines are shortening, it means the trend is weakening and a trader can anticipate a possible trend change.
What is MACD Divergence? How to Use MACD to Trade Divergences
The MACD histogram is a visual tool that measures the difference between the MACD line and the signal line. The histogram grows as the speed of price movements increases and trends strengthen. When the histogram decreases, the trend, momentum, and speed of price movements could be weakening.
A divergence can appear on the histogram if the price action does not move in the same direction as the indicator. A bearish divergence appears when the price records a higher high but the MACD registers lower highs. A bullish divergence appears when the price records lower lows but the MACD indicator shows higher lows.
Divergences can be detected by drawing trend lines through a series of swing highs or swing lows. This provides a better understanding of whether there are divergences between the price and the technical indicator. Trading divergences can be complicated and is not recommended. Divergences are only confirmed in hindsight and can lead traders to be tricked or lose money.
However, a trader reading MACD divergences can be warned of a potential trend change, allowing them to prepare accordingly and look for signals and support patterns that could confirm the setup.
How to Use MACD in the Crypto Market
Here is an example of how to use MACD to trade cryptocurrencies like Bitcoin, Ethereum, Litecoin, XRP, or other altcoins.
In the BTC example above, the MACD is converging towards the zero line. Either the MACD crosses bearishly and prices fall, or the MACD diverges from this point and prices soar upward on increasing momentum.
From a technical point of view, it is then important to consider the other elements on the chart. Bitcoin is also supported by a minor bullish trendline (dotted orange line) and there is a potential bull flag. If the price collapses below the trendline with a bearish crossover, a further decline should then be confirmed. If, on the contrary, the price rises and the MACD diverges, a significant rise should follow. To see these concepts in action on a live chart, you can explore more strategies with advanced charting tools.
Using MACD: Advantages and Disadvantages
Like any tool, there are always advantages and disadvantages. Some indicators give false positives, lag behind trend changes, or create other problems.
Here are some of the most common advantages and disadvantages of using the MACD indicator:
Advantages of MACD in Crypto Trading
- Measures Momentum: Provides clear insight into the strength of a price trend.
- Easy to Read: The visual cues of lines and histograms are straightforward to interpret.
- Trend-Following: Excellent for identifying and staying with established trends.
- Precise Buy/Sell Signals: Crossovers offer specific points for potential entry and exit.
Disadvantages of MACD in Crypto Trading
- Lagging Indicator: Because it uses EMAs, it reacts slower than the price action itself.
- False Signals: Can generate whipsaws, especially in sideways or choppy markets.
- No Custom Parameters: The default settings may not be optimal for all market conditions or assets.
How to Avoid False MACD Signals: Understanding Lagging Signals
MACD is a trend-following momentum indicator. This means that the trend can sometimes change before the MACD provides a crossover or signal. MACD has thus gained a notorious reputation for being a lagging indicator. Many claim that MACD is not a great trading tool, while others swear by its use.
However, there are several ways to use MACD effectively. MACD is an excellent tool for spotting divergences. Positive divergences are not signals to trade actively, but they can indicate to a trader that a trend change might occur, allowing them to prepare accordingly.
MACD also works well in conjunction with other technical indicators, such as RSI, Stochastic, Bollinger Bands, etc. Traders can look for potential Japanese candlestick patterns or watch for MACD crossovers at support or resistance levels to further improve results using this tool.
MACD vs. Relative Strength Index (RSI)
The RSI and MACD indicators are two of the most used momentum indicators by cryptocurrency traders. Although they both measure momentum and the speed of price movement, the way each tool provides signals is different.
The Relative Strength Index (RSI) indicates whether an asset is overbought or oversold relative to recent price action. The RSI by default takes the average of gains and losses over 14 periods. Traders can go further with custom RSI settings.
MACD is an unbounded oscillator, while RSI is bounded by a scale of 0 to 100. An RSI value above 70 corresponds to an overbought situation, while a value below 30 corresponds to an oversold situation. Values below 50 are bearish and values above 50 are bullish. Since cryptocurrencies are speculative assets, they can be overbought or oversold for long periods compared to other assets.
MACD measures the convergence or divergence between the MACD line and the signal line, while RSI focuses on the gains and losses of the average price over a given period. Since the two indicators work differently, they can generate contradictory signals. On the other hand, when both technical indicators give similar signals, it indicates to traders that they have additional confirmation and that the probability of their trade being profitable is higher.
Frequently Asked Questions (FAQ)
What is MACD in crypto?
In crypto, MACD is a popular technical analysis tool and a trend-following momentum oscillator that can be used to generate buy or sell signals, indicate whether a market is bullish or bearish, and tell a trader if an asset is potentially oversold or overbought.
What does MACD stand for?
MACD stands for "Moving Average Convergence Divergence." Its signals are provided when the MACD line and the signal line converge or diverge in one direction or the other. Convergence can lead to crossovers and changes in momentum, while divergence of the two lines can lead to a continuation of the trend. This should not be confused with bearish or bullish divergence, which can signal a potential trend change.
Does MACD work with cryptocurrencies?
MACD is one of the best tools to use with cryptocurrencies like Bitcoin, Ethereum, and other altcoins. It provides effective signals indicating that momentum has shifted in the category of highly volatile assets.
How to use the MACD indicator in crypto?
Using the MACD indicator in crypto involves looking for potential crossovers and changes in momentum. It can also be used to find bullish and bearish divergences. This tool can also be used to determine if an asset is bullish or bearish, or oversold or overbought.
Is it profitable to use MACD in crypto trading?
MACD can be a profitable technical trading indicator when used in conjunction with other indicators, support and resistance, charts, Japanese candlesticks, and more. The signals it emits are not always reliable, and it has a reputation for being a lagging indicator.
Is MACD a good indicator?
The MACD indicator is one of the most popular in technical analysis for a reason! This tool is ideal for backtesting results and for finding potential setups before they happen. The key is to use MACD to look for potential divergences, then use RSI or other tools or signals and wait for confirmation. Combining these tools increases the chances of success.
What is the best MACD technique?
In most cases, the classic MACD is the best solution when set to default. However, if you observe large price movements over a longer period, such as the full price history of Bitcoin, using a logarithmic price chart in conjunction with LMACD can be even more effective. LMACD is the logarithmic version of MACD. The latter makes it easier to compare previous price movements based on momentum.
Which is better, MACD or RSI?
RSI is a better technical indicator for taking positions. Nevertheless, there is no better tool than MACD for detecting major momentum changes. These often occur on prices before they occur on the MACD, giving the indicator a bad reputation as a lagging indicator. On the other hand, when used to anticipate movements that are then confirmed by the RSI, MACD and RSI can be a winning combination. To get the most out of these tools, consider how to get advanced methods for combining indicators.