How to Use the MACD Indicator in Trading

The Moving Average Convergence/Divergence, or simply MACD indicator, belongs to the momentum oscillator family. It is used in trading to identify uptrends and downtrends. Even though the indicator belongs to the oscillator family, this indicator isn’t used to spot overbought and oversold points.

The indicator on a chart looks like two lines that don’t move along any set boundaries. The first and more curvy line of blue color is the MACD line. The second one, red color, is a signal line, and it’s a lot smoother compared to the MACD line.

There is also a third line called a histogram. It simply shows the difference between MACD and signal lines. When lines cross, the indicator shows signals similar to the two moving average systems.

These lines reflect the relationships between two exponential moving averages (EMA). But how to use MACD in trading, and what does it mean in stocks? Keep reading the article to learn more about the Moving Average Convergence/Divergence and how traders successfully use it to make a profit.

What Is a MACD Indicator

To figure out how to use the indicator in trading, let’s start with an explanation of what is MACD indicator. Let’s learn more about all the components of the indicator, what they reflect, and how to interpret signs. Understanding MACD should help you to use the indicator in trading.

Take a look at any standard MACD trade chart. Apart from showing lines, it reflects three numbers used as settings:

The standard setting for the chart is “12, 26, 9”, and this is how the setting should be interpreted:

Note MACD is not moving averages of the price. As mentioned, the indicator has two lines, plus the histogram.

MACD Interpretation

The blue MACD line reflects the distance or difference between two EMAs. It’s a faster average as it moves faster toward the signal line. If the setting is standard, then the MACD line shows the difference between two periods, 12 and 26.

The red signal line reflects the moving average of the MACD line. It is slower than the blue line and is typically smoother. This slow-moving average reflects the average of the previous MACD line. In a standard setting, it’s the 9-period EMA.

What does it mean? It means that the trader takes the moving average of the last 9-day period of the fast average and uses it as a slow-moving average for a current period. This slower average aims at making the MACD average smoother.

The histogram reflects the difference between MACD and Signal. It is merely a graphical reflection of the distance or difference between these two averages. Paying attention to the histogram may sometimes give an indication of a crossover and a potential trend.

Typically, when the histogram gets bigger whenever MACD diverges from Signal. But when the histogram gets narrower, MACD converges toward Signal. That’s why the indicator is called moving averages convergence divergence.

How to Use the MACD Indicator in Trading

What does MACD Mean in Stocks?

But what does MACD mean in stocks? The indicator determines the trend strength or momentum. To spot the trend, use MACD and zero lines. Here is what they show:

The indicator can also be used to determine entry and exit points. Here is how to spot these signals:

This is the simplest way to use the indicator. But now, let’s dive into the details.

How to Use MACD

Since there are two different moving averages running with different speeds, the faster one will react faster, reflecting potential signals.

The occurrence of a new trend is reflected by the faster line moving towards the slower one. It will eventually cross the slow red line.

As soon as the blue line crosses the red one, the blue line starts to move away or diverge. That’s an indication of a trend. Note it’s essential to pay attention to the direction of the blue line. If it moves upward and crosses the red line, then it’s an uptrend. If it moves downward, crosses the red line, and keeps moving down, then it’s an indication of a downtrend.

When crossovers occur, the histogram temporarily disappears. It’s because there is no difference between moving averages. The histogram appears again as soon as the blue line diverges or converges from the red one.

So, now you know how to spot an uptrend and downtrend, but how can you tell if the trend is strong? If the fast blue line moves far away from the slow red one, then it’s a typical indication of a strong trend. Depending on the position where a blue line crosses the red one, it could be a strong uptrend or downtrend.

Buying stock before the strong uptrend and then selling it before the strong downtrend is an excellent way to make a significant profit.

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Carolyn Huntington is an economist, professional trader, and analyst. She made her first big deal in her student years with a profitable investment in Facebook stock. Now the total experience of her trade is 18 years. Over the years of trading, Carolyn has developed its own strategy that allows even those who have never traded on the stock exchange before to earn money. She also creates market forecasts and advises major shareholders, compiles investment portfolios, and teaches how to work with automated advisors.