By using the tool in the direction of the trend, the chart below highlights three profitable trades and one losing trade. By waiting for two counter-trend moves in the histogram, it mitigates the chance that such a move will be a one-off rather than a reversal. The chart below highlights the potential to utilise the MACD histogram as a trading tool. The histogram reversal is based on using known trends as the basis for placing positions, which means the strategy can be executed before the market movement actually takes place. This is a leading strategy, in contrast to the lagging crossover strategy mentioned above. Once the initial expansion phase is over, a hump shape will likely emerge – this is a signal that the moving averages are tightening again, which can be an early sign that a crossover is impending. This means that as the bars on the histogram move further away from zero, the two moving average lines are moving further apart. When the market price is moving strongly in a direction, the histogram will increase in height, and when the histogram shrinks, it is a sign the market is moving slower. The histogram is arguably the most useful part of MACD, with the bars representing the difference between the MACD and signal lines. Profitable entry points are highlighted by the green vertical lines, while false signals are highlights by the red lines. The chart below highlights this standard crossover strategy. It is worth noting that strategies which utilise price action for confirmation of a signal are often seen as more reliable. This would then be considered a ‘false signal’. The main issue faced by the MACD in weaker market trends, is that by the time a signal is generated, the price may be reaching a reversal point. Conversely, when the MACD line crosses below the signal line it provides a bearish sell signal.Īs the crossover strategy is lagging by nature, it is based on waiting for a movement to occur before opening a position. As with most crossover strategies, a buy signal comes when the shorter-term, more reactive line – in this case the MACD line – crosses above the slower line – the signal line. The MACD line and signal line can be utilised in much the same manner as a stochastic oscillator, with the crossover between the two lines providing buy and sell signals. While traders might opt to enter a short position if the asset was in a downtrend, characterised by the lower highs and lower lows, or breaks in support levels. If the market price was found to be trending upward – reaching higher highs and higher lows, as well as breaking key levels of resistance – traders might enter long positions. If the MACD were to be trading above the zero line, it would confirm an uptrend, below this and the indicator would be used to confirm a downtrend. The difference between the two lines is represented on the histogram. If the two moving averages come together, they are said to be ‘converging’ and if they move away from each other they are ‘diverging’. The main, slower line is the MACD line, while the faster line is the signal line. The two lines within the indicator may look like simple moving averages (SMAs), but they are in fact layered exponential moving averages (EMAs). The MACD indicator works using three components: two moving averages and a histogram.
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