The Moving Average Convergence Divergence, also known as MACD, is a trend-following momentum indicator that is widely used by traders. Although the MACD is a lagging indicator, it can be very useful in identifying possible trend changes.
The MACD oscillates above and below a zero line, also known as the center line. The shorter moving average is subtracted from a longer moving average to get the value of the MACD. A signal line representing the exponential moving average of the MACD completes the indicator.
The blue line is the MACD and the red line is the signal line. When the blue line crosses the red line it is a buy signal and when the blue line falls below the red line it is a trigger to sell. A cross above the center line is also a buy-signal.
Let’s see how you can use the indicator to get better entries and exits from a wide variety of positions. Then we examine how the MACD is analyzed during pullbacks and in an uptrend. Finally, let’s take a quick look at the importance of divergence in MACD.
Adjustment of the indicator to the volatility of the crypto market
Compared to legacy markets, cryptocurrencies experience large movements in a short period of time. Hence, the entries and exits should capture a large portion of the movement quickly, but without too many whipsaw trades.
When a new uptrend begins, it typically stays in place for a few weeks or months. However, every bull phase has its share of corrections. Traders should try to stay with the trend and not be stopped by every small pullback along the way.
The goal should be to take the position early when the new uptrend begins and stay in position until a trend reversal is signaled. Easier said than done, however. If the indicator gives too many signals, it will result in several unwanted trades that generate high commissions and are emotionally stressful.
On the other hand, if the time frames are chosen to give fewer signals, a large part of the trend could be overlooked as the indicator detects slow reversals.
This problem was addressed by MACD inventor Gerald Appel in his book Technical Analysis: Power Tools for active Investors.
Appel highlights how two MACD indicators can be used on strong trends, the more sensitive being used for entries and the less sensitive being used for exits.
Related: Not sure if you want to buy the dip? This important trading indicator makes it easier
Are two MACDs better than one?
The default value for the MACD indicator used by most charting software is the 12 to 26 day combination. However, for the following examples we will use a MACD with the 19- to 39-day combination, which is less sensitive and is used to generate sell signals. The second is more sensitive and uses the 6- to 19-day MACD combination used for buy signals.
Bitcoin (BTC) was trading in a small range in September 2020 and during that time both MACD indicators were largely unchanged. In October, when the BTC / USDT pair started an uptrend, the MACD gave a buy signal when the indicator crossed the midline in mid-October 2020.
After entering the trade, watch the MACD get close to the signal line four times (marked as ellipses on the chart) in the sensitive 6- to 19-day MACD combination. This could have resulted in an early exit and left a large portion of the profits on the table as the uptrend was just beginning.
On the other hand, notice how the less sensitive 19- to 39-day combination stayed stable during the uptrend. This could have made it easier for the trader to stay in trading until the MACD fell below the signal line on November 26, 2020, which triggers a sell signal.
In another example, Binance Coin (BNB) crossed the center line on July 7, 2020 and triggered a buy signal. However, the sensitive MACD turned down quickly and fell below the signal line on July 6th as the BNB / USDT pair took a minor correction.
In comparison, the less sensitive MACD stayed above the signal line through August 12, 2020, capturing a larger portion of the trend.
Traders who find it difficult to keep track of two MACD indicators can also use the standard 12 to 26 day combination. Litecoin (LTC) ‘s journey from around $ 75 to $ 413.49 generated five buy and sell signals. All trades produced good entry (marked as ellipses) and exit signals (marked with arrows).
Similar: 3 Ways Traders Use Moving Averages To See Market Dynamics
How the MACD can signal corrections
Traders can also use the MACD to buy pullbacks. During corrections in an uptrend, the MACD falls on the signal line, but when the price resumes its uptrend, the MACD bounces off the signal line. This formation, which resembles a hook, can be a good entry point.
In the example above, Cardano (ADA) crossed the center line on January 8, 2020, signaling a buy. However, when the upward movement stalled, the MACD fell close to the signal line on January 26, 2020, but did not break below it. As the price rallied, the MACD broke off the signal line and continued its upward movement.
This provided traders with an opportunity not to buy the cross above the midline. The sell-signal was generated on February 16th when the ADA / USDT pair initiated a deep correction.
MACD divergences can also signal a trend reversal
Bitcoin’s price continued to hit higher highs between February 21, 2021 and April 14, but the MACD indicator hit lower highs during the period and formed a bearish divergence. This was a sign that the momentum was weakening.
Traders should be wary of bearish divergence and avoid long trades during such a period. The long bearish divergence culminated in a massive decline in this case.
Litecoin shows how the MACD formed a bullish divergence during a sharp downtrend from July to December 2019. Traders who bought the crossover above the midline may have been misled in September and again in November.
This shows that traders should wait for the price action to show signs of reversal before reacting to the MACD divergences.
A couple of key takeaways
The MACD indicator captures the trend and can also be used to measure the dynamics of an asset. Depending on market conditions and the asset being analyzed, traders may vary the period setting of the MACD. If a coin is a fast move, a more sensitive MACD could be used. The default setting or a less sensitive MACD can be used for slow movers. Traders can also use a combination of a less sensitive and a more sensitive MACD indicator for better results.
However, there is no perfect indicator that works all the time. Even with the above permutations and combinations, trades will develop contrary to expectations.
Traders should employ money management principles to quickly reduce losses and protect paper profits when the trade moves as expected.
The views and opinions expressed are those of the author only and do not necessarily reflect the views of Cointelegraph.com. Every step of investing and trading involves risk, so you should do your own research when making a decision.