Moving Average Convergence Divergence, also known as MACD, is a trend-following momentum indicator widely used by traders. Although MACD is a lagging indicator, it can be very useful in identifying potential trend changes.
MACD oscillates above and below a zero line, also known as the center line. The shorter moving average is subtracted from the longer moving average to arrive at the value of MACD. A signal line, which is 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 above the red line, it is a buy signal and when the blue line crosses below the red line, it is a trigger to sell. A cross above the center line is also a buy signal.
Let us see how to use the indicator for better entries and exits from different positions. Later, we will examine how the MACD is analyzed during a pullback and in an uptrend. Finally, we will take a brief look at the significance of divergence on MACD.
Adapting Indicator to Crypto Market Volatility
Compared to older markets, cryptocurrencies tend to witness large volatility in a short period of time. Therefore, entries and exits should be quick to capture a large portion of the move, but without too many whipsaw trades.
When a new uptrend begins, it usually remains in force for a few weeks or months. However, every bull phase has its share of corrections. Traders should aim to stay with the trend and not get out of the way with every minor flaw that comes their way.
One should aim to enter the position early as soon as a new uptrend begins and stay with the position until a trend reversal is signaled. However, doing so is easier said than done. If the indicator signals too high, there will be many unwanted trades that will take large commissions and be emotionally exhausted.
On the other hand, if the time frame is chosen to signal low, a large part of the trend may be missed as the indicator will be slow to identify reversals.
This problem was addressed by MACD creator Gerald Appel in his book, Technical Analysis: Power Tools for Active Investors.
Appel highlights how two MACD indicators can be used during strong trends, the more sensitive one is used for entries and the less sensitive one is used for exits.
Are two MACDs better than one?
The default value used for the MACD indicator by most charting software is a 12- to 26-day combination. However, for the later examples, let’s use a MACD in conjunction with the 19- to 39-day which is less sensitive and will be used to generate sell signals. The second one will be more sensitive, using a 6- to 19-day MACD combination that will be used to generate buy signals.
bitcoin (B T cSeptember 2020 was trading in a narrow range and both the MACD indicators were largely flat during that time. In October, as the BTC/USDT pair started an uptrend, MACD gave a buy signal when the indicator crossed the center line in mid-October 2020.
After entering the trade, observe how the MACD came close to the signal line on four occasions (marked as ellipsis on the chart) on the sensitive 6- to 19-day MACD combination. This could have resulted in an early exit, leaving a substantial portion of the profit on the table as the uptrend was only just beginning.
On the other hand, notice how the less sensitive 19- to 39-day combination remained stable during the uptrend. This would have made it easier for the trader to stay in the trade until the MACD breaks below the signal line on November 26, 2020, triggering a sell signal.
In another example, Binance Coin (bnb) crossed the center line triggering a buy signal on July 7, 2020. However, the sensitive MACD closed quickly and fell below the signal line on July 6th as the BNB/USDT pair made a minor correction.
Comparatively, the less sensitive MACD remained above the signal line until August 12, 2020, capturing a large portion of the trend.
Traders who find it difficult to keep track of the two MACD indicators can also use the default 12- to 26-day combination. Litecoin (LTC) from approximately $75 to $413.49 generated five buy and sell signals. All trades generated good entry (marked with ellipses) and exit (marked with arrows) signals.
How can MACD signal a correction?
Traders can also use MACD to buy pullbacks. During a correction in an uptrend, the MACD falls to the signal line, but as price resumes its uptrend, the MACD rebounds from the signal line. This hook-like formation could give a good entry opportunity.
In the example above, Cardano (ada) crossed the center line indicating buy on January 8, 2020. However, as the up-move halted, the MACD fell close to the signal line on January 26, 2020, but did not break below it. As the price corrected, MACD broke away from the signal line and resumed its move.
This gave an opportunity to traders who missed to buy the cross above the center line. A sell signal occurred on February 16, when the ADA/USDT pair was starting a deep correction.
MACD divergence can also indicate a trend change
The price of bitcoin remained consistently high between February 21, 2021 and April 14, but the MACD indicator made lower highs during this period creating a bearish divergence. This was a sign that momentum was weakening.
Traders should be cautious when a bearish divergence occurs and avoid trading for long periods during such periods. In this case the long bearish divergence ended with a huge downside.
Litecoin shows how the MACD formed a bullish divergence during a strong downtrend from July to December 2019. Traders who buy crossovers above the center line may be alerted in September and again in November.
This suggests that traders should wait for price action to show signs of reversing their trend before acting on the MACD divergence.
some important measures
The MACD indicator captures the trend and can also be used to measure the momentum of an asset. Depending on the market conditions and the asset being analyzed, traders can determine the duration of the MACD. If a coin is going to be bullish, the more sensitive MACD can be used. With slower movers, the default setting or the less sensitive MACD may be used. Traders can also use a combination of the less sensitive and more sensitive MACD indicators for better results.
However, there is no one perfect indicator that works all the time. Even with the above permutations and combinations, trades will go against expectations.
Traders should apply money management principles to minimize losses quickly and protect paper gains as traded.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, so you should do your own research when making a decision.