Jul 20, 2021
3 mins read
MACD (Moving Average Convergence Divergence)
Before Knowing how to use this indicator we should know how it works and in the end, we’ll know the Disadvantages of this indicator with false signals and some tips from my experience of using this indicator.
MACD is a momentum indicator that consists of two Exponential moving averages i.e 26-period moving average and 12-period moving average.
The difference between the two is MACD line. A 9-day EMA of MACD is then plotted on the top of MACD line which is called the Signal line.
When the MACD line Crosses above the Signal line it indicates a Buy Signal and MACD line Crosses below the Signal line it indicates a sell signal. Let’s Understand this on a chart.
Blue line on the chart is MACD line and Redline is the Signal line. As you can see when macd line crosses above the signal line it is a bullish/buy signal and the coin has moved up giving you a profit of around 10–12% in 18–20 days.
As we can see when the macd line crosses and goes below the signal line it gives a bearish/sell Signal. In Chart 2 of BTC?USD the coin has fallen from 10056-7100 giving almost 32% Profit.
Now Coming to Convergence and Divergence, Convergence is where the two points will meet and close towards each other. Divergence is where two lines are going further away from each other. Now the question arises what’s the use of this in Macd let’s understand that through a chart.
Now in Chart 3 you’ll see as two lines go further away from each other and more they go away from each other the trend is getting stronger and in chart 4 when they are closing more toward each other the trend gets weak and weak and eventually reverses.
Now coming to histogram it plays an important role to get to know the strength of the trend through the length or height of bars in the histogram. Let’s see it on the chart.
You’ll be able to see the increasing length of the bars in the histogram where it indicates the trend is still gaining strength and eventually the length of bars is getting smaller and smaller indicating the trend is getting weak and will reverse.
So now we’ve seen how Macd works so does that mean we can start winning trades now?
NO! most of the you-tubers teaching technical analysis will show you up to this only.BUT we should also know the flip side of the coin too.
So now we’ll know the Disadvantages of this indicator:
Macd is made up of moving averages. Anything that is made up of moving averages is a lagging indicator.
The above image tells us that the trend has already started and after some time macd gives a buy signal. This can be up to 4–5 days late and in this, it's costing you almost 2700 points.
This indicator does not work in a consolidated or a sideways market.
As you can see there is a lot of indecisiveness in the indicator in a sideways market. A new trader will lose a lot of money in this scenario as his stop-losses will hit first then his targets will.
Sometimes a lot of fake signals is being provided by this indicator where a buy signal will not be in tangent to prices moving up.
We can see in the above chart that there is clearly a crossover with a buy signal but the market has gone opposite in the next few sessions and many people would hit their stop-losses first.
Now coming to some of the TIPS:
Never buy when the indicator gives a buy signal and the crossover is above 0 line or positive(You can see that in the right bottom of the image) (You can see the above chart)
And same goes for selling, never sell when the crossover is below zero or negative. ( See the below chart)
The reason is whenever the above two things occur market will go either sideways or opposite of what the indicator is saying, as the momentum which the indicator is signalling has already been exhausted and you won't be able to capture the big movement.
Small Histograms usually indicates a sideways or indecisive market avoid taking a trade in in those situations.
So these are some of the things which I've observed over time.
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