The MACD indicator can generate a variety of signals, including:
Crossovers:
The most common trading technique with the MACD indicator is to look for crossovers. A crossover occurs when the MACD line crosses above or below the signal line. A bullish crossover (bullish means where prices are going up) is a signal that the price trend is likely to change from bearish (bearish means where prices are going down) to bullish. A bearish crossover is a signal that the price trend may change from bullish to bearish.
Zero-line crossovers:
This is where the MACD line crosses the zero line. When the MACD line crosses above the zero line, this is considered as a bullish signal (prices are likely to go up). When the MACD line crosses below the zero line, this is considered as a bearish signal (prices are likely to go down).
Divergence:
Divergence occurs when the price of an asset moves in one direction whereas the MACD indicator line moves in the opposite direction. Divergence is often an early warning signal price trend may be about to reverse.
Histogram:
The histogram (the difference between the MACD line and the signal line) when positive (where the histogram is above the zero line) is considered as a bullish market condition. On the flip side when negative (where the histogram is below the zero line) is considered as a bearish market condition.
As with all indicators and technical analysis techniques used in trading, it's crucial to realise the MACD indicator is not a perfect indicator and it can and will generate false signals. Traders tend to therefore use other indicators in conjunction with MACD to validate their trade entry/exit decisions.
Here are some additional suggestions when using the MACD indicator for signal identifcation in trading:
Use multiple timeframes:
The MACD indicator should be used over multiple timeframes, the longer the timeframe the better ie daily, weekly, and monthly charts. Using the longer timeframes as an initial starting point for trade analysis will greatly asist the trader understand the overall market conditions and prevailing major trend in the underlying asset being analysed.
Use other indicators:
Many web resources suggest using the MACD indicator with other indicators such as RSI (Relative Strength Index) and Stochastic Oscillators to validate the trading decision. We would also recommend using MACD with price derived support and resistance trading techniques such as major pivot levels and historical highs/lows which more often than not form support and resistance levels in the future. There is a saying that price has memory!
Backtest:
If you can get a historical data source which is contiguous backtesting has validity. However, traders should be careful when using backtesters included within trading platforms unless they have carefully inspected the data sample on which the backtester is running. There are often 'holes' in the historical broker data which can make a big difference to the backtest results - so careful data preparation and checking for contiguous data is really important before one should take backtest results too seriously. Furthermore, it's also important to note that equity curves produced by EA vendors selling black box automated trading system have often been optimised for the sample data or 'curve fitted' to the sample data. These systems will generally never be able to produce the backtest results they claim in a forward test environment. So tread carefully with backtesting.
Do you have more questions about MACD? Click on the links below to find out the answers to these commonly occuring questions regarding the MACD indicator:-