The MACD technical indicator is generally regarded a lagging momentum indicator. Nevertheless, it can also be used to forecast market turns and pullbacks if applied properly. In this article readers will learn how to day trade this technical indicator, or just understand its characteristics so it can be included as part of another trading system.
MACD Chart Setup
The MACD technical indicator reveals trade signals by plotting the relationship between two EMA (exponential moving average). In its default setting, the indicator uses a 26-day and a 12-day EMA, with some charting packages including a histogram to add sophistication to the indicator and any trading strategy that uses it.
The quality of MACD trade signals can be greatly improved by using them with other technical indicators and chart patterns. While it is true the this strategy will invalidate some good trade signals, the practice is more likely to weed out more bad than good trade signals. Consider applying this indicator to all timeframes that are traded. It is especially important that it is applied to larger timeframes, such as the daily charts to get a wider view of the market.
MACD Buy and Sell Signals
While some traders will invariably come up with unique and novel MACD trading systems, MACD trade signals are usually indicated by: crossovers, divergences and dramatic rises in the technical indicator.
Crossovers - A simple MACD trading strategy is to short the market when the MACD moving averages and histogram crosses down at the same time, and visa versa for long trades. A point of caution though, traders often enter trades prematurely when it appears that a trading signal is forming. However, no trading signal is confirmed until the candle for the period has closed. This is because the market can reverse or bounce just before the cross is confirmed, in which case the trade signal becomes invalid; see figure 1.
Divergence – The MACD indicator usually signals that a turn around is about to occur when the security price diverges from the indicator. For example, if the market has made a new high but the MACD fails to also make a new high, a reversal is forecasted. In these instances, the MACD is said to be a forward-looking indicator because of this forecasting characteristic.
Dramatic rise or fall - Another signal that a reversal could occur, or that a security is overbought/oversold happens when the shorter moving average moves away from the longer-term moving average in a dramatic manner. If the trend remains intact this pattern could signal that a pullback, in the price of the security, could occur before the moves continues.
Use dramatic moves to identify instances when the market could pullback prior to continuing the current trend, or use trend lines and other indicators to identify market turns.
Finding Good MACD Trade Signals
Generally speaking, it is better to trade in the direction of the trend. Doing so improves the chances of a trade being profitable. Even if a long trade was entered high, or a short trade was entered low, the market may forgive that trading error by virtue of the fact that the trade was entered to take advantage of the momentum and general trend of the market.
The principle is also true when trading a MACD strategy; it is better to ignore all MACD trade signals that oppose the general trend. If one is day trading intra-day timeframes (i.e., 15min, 1hr and 3hr charts), look to the daily charts to get a sense of the overall direction and momentum of the market before deciding on whether to go long or short and a particular instrument.
Steve McFarlane - I am a professional freelance writer who is passionate about bringing quality and relevant content to my audience of readers. I strive to ...
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