The MACD is a momentum-based trend indicator used to identify trending phases, trend change, and momentum in the price actions of a financial instrument.
The three components of the MACD
The MACD, or Moving Average Convergence/Divergence indicator, is a popular indicator used in technical analysis. The indicator was first created in the late 1970s by Gerald Appel.
In this article, we discuss several short-term trading applications using the MACD indicator in conjunction with other technical analysis tools.
Moving Average Convergence/Divergence (MACD) is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The resulting line is called the MACD line. A 9-period EMA of the MACD line is then plotted as a signal line. Overall, there are three key components of the MACD:
- MACD line (the difference between the 12-period EMA & 26-period EMA)
- Signal line or smoothing line (9-period EMA of the MACD line)
- Histogram (the distance between the MACD line & Signal line)
Source: Tradingview. Past performance is not indicative of future results.
How can the MACD indicator be used in trading?
The MACD indicator can be used in a variety of ways, but some of the most common include:
Identifying trend conditions
A bullish trend condition can be indicated by a rising MACD line above the zero centreline. In contrast, a declining MACD line below the zero centreline suggests a bearish trend condition.
Identifying trend changes
The MACD line can be used to identify trend changes by looking for crossovers between the MACD line and the signal line. A crossover from below the signal line to above the signal line is a bullish signal, while a crossover from above the signal line to below the signal line is a bearish signal.
Identifying divergences
Divergences are a technical analysis pattern that can signal a potential price action reversal through the easing of momentum. A bullish divergence occurs when the MACD line makes a higher low than the previous low below the centreline, in contrast with the price of the financial instrument that has continued to make a lower low. A bearish divergence occurs when the MACD line makes a lower high than the previous high above the centreline, while the price of the financial instrument has continued to trade higher.
Short-term trend-following and countertrend trading set-ups
Source: Tradingview. Past performance is not indicative of future results.
The price actions of the EUR/USD have evolved into a short-term uptrend phase from the 2 November 2023 low to the 6 November 2023 high, reinforced by a reintegration back above the 20-day moving average and a bullish breakout above 1.0668 resistance.
For a bullish trend-following trading set-up, we will ideally want the price actions to stage a pull-back towards support to obtain a better reward-risk ratio and wait for a bullish signal to occur before putting in an entry; an indication that potential bullish momentum has resurfaced.
In this example, the EUR/USD has pull-backed subsequently after 6 November 2023 and hit the 1.0668 former resistance now turns to pull-back support on 7 November 2023.
Thereafter, we will wait for a bullish signal to appear via the MACD indicator, and a bullish crossover was flashed out on 8 November 2023 at 2.00 am (UTC + 8) hourly period which suggests a potential revival of the bullish trend condition. A bullish entry can be initiated at the next opening hour period.
Price actions of EUR/USD have managed to rally higher after 6 days from the bullish entry as it broke above the former minor swing of 1.0757 high on 14 November 2023.
Source: Tradingview. Past performance is not indicative of future results.
The price actions of the EUR/USD have evolved into a short-term downtrend phase from the 10 August 2023 low to the 18 August 2023 low as it traded below the 20-day moving average and was reinforced later by a bearish breakdown below 1.0935 support.
For a bearish trend-following trading set-up, we will ideally want the price actions to stage a snap-back towards resistance to obtain a better reward-risk ratio and wait for a bearish signal to occur before putting in an entry.
In this example, the EUR/USD has snap-backed subsequently after 18 August 2023 and almost hit the 1.0935 former support now turns snap-back resistance on 22 August 2023.
Thereafter, we will wait for a bearish signal to appear via the MACD indicator, and a bearish crossover was flashed out on 22 August 2023 at 6.00 pm (UTC + 8) hourly period which suggests a potential revival of the bearish trend condition. A bearish entry can be initiated at the next opening hour period.
Price actions of EUR/USD have managed to trade lower after 1 day from the bearish entry as it broke below the former minor swing low of 1.0845 on 23 August 2023.
Source: Tradingview. Past performance is not indicative of future results.
The short-term downtrend of the EUR/USD has been reinforced after its price actions staged a bearish breakdown below its 20-day moving average on 4 December 2023 and subsequently shaped a series of “lower lows”.
On 12 December 2023 at 2.00 am (UTC + 8) hourly period, it managed to stage a bounce right above its recent minor swing low of 1.0724. In addition, the MACD line has flashed out a bullish divergence condition below the centreline which suggests a potential easing of the downside momentum of the ongoing short-term downtrend phase.
The odds now have increased for a bullish countertrend rebound set-up opportunity for the price actions of EUR/USD to potentially stage a mean reversion towards its 20-day moving average now acting as a resistance at around 1.0870.
A bullish entry can be initiated at the next opening hour period after the first bullish candle. Thereafter, the price actions of EUR/USD managed to stage the expected bullish countertrend rebound and hit the 20-day moving average (resistance) two days later on 4 December 2023.
Source: Tradingview. Past performance is not indicative of future results.
The EUR/USD has evolved into a short-term uptrend phase after a clearance above the 20-day moving average on 7 July 2023 and subsequently shaped a series of “higher highs.”
On 18 July 2023 at 8.00 pm (UTC + 8) hourly period, it managed to stage a retreat right below its recent minor swing high of 1.1275. In addition, the MACD line has flashed out a bearish divergence condition above the centreline which suggests a potential easing of the upside momentum of the ongoing short-term uptrend phase.
The odds now have increased for a bearish countertrend decline set-up opportunity for the price actions of EUR/USD to potentially stage a mean reversion towards its 20-day moving average now acting as a support at around 1.1019.
A bearish entry can be initiated at the next opening hour period after the first bearish candle. Thereafter, the price actions of EUR/USD managed to stage the expected bearish countertrend decline and hit the 20-day moving average (support) seven days later on 25 July 2023.
This article and its contents are intended for educational purposes only and should not be considered trading advice.
