The MACD, which is short for Moving Average Convergence Divergence, is an incredibly important tool to most traders, and for good reason. It’s a great technical indicator for signaling when is the best time to buy, and when is the best time to sell an asset. By using two separate moving averages, the tool gives a depiction of the strength of a trend and provides a signal when the trend is going to change. This is done by subtracting the 26-day EMA from the 12-day EMA, and using a nine-day EMA of the MACD itself as a signal line. Because the MACD trading strategy is so simple to understand, it has become a prime tool in the profitable traders’ tool box! Here’s how it all works…
The Pieces Of The MACD Puzzle
At the end of the day, there are really only two parts to the MACD that traders should keep a close eye on. Those include:
- MACD Line: First and foremost, we have the MACD line, which is ultimately the life-blood of the indicator. The MACD line is a line that is created by subtracting the 26 day EMA from the 12-day EMA. The result of the subtraction leads to a measurable data point that can then be tracked on a chart.
- Signal Line – The signal line is an exponential moving average, or EMA, of the MACD line itself. It is a 9 day average, meaning that every day, the 9th day falls off, and the new day is added into the average.
What The MACD Line Tells You
Ultimately, the MACD line tells you just how strong, or how weak for that matter, a trend actually is. The closer the MACD is to zero, the weaker the trend is. However, the further the MACD is to zero, the stronger a trend is. So, essentially, when the MACD his a high number, the trend is likely to stick around for a while. However, as the MACD nears zero, the trend becomes more and more likely to reverse directions.
What The Signal Line Tells You
The signal line is ultimately used for crossovers, giving traders buy and sell signals. The way this is done is by following the signal line through the chart. When the signal line crosses above the MACD line, it’s a buying signal; essentially telling the trader that the value of the financial asset is likely to rise in the near term. However, when the signal line crosses below the MACD line, it’s a sell signal. This crossover tells traders that the value of the financial asset is likely to fall ahead. So, by paying attention to the MACD line, you get an idea of the strength of a trend while by paying attention to the signal line in relation to the MACD line, you get a good understanding of the direction of the trend and a warning if that direction is likely to change.
At the end of the day, the MACD has become a favorite tool for profitable traders for one very good reason, it works. Ultimately, it runs on the premise that history repeats itself, and by following moving averages, you can predict future movements. Through the use of the MACD, several traders are out there turning a profit right now. So, it’s time for you to open your chart and do the same!