How to Read MACD

How to Read MACD Indicator

15 min read

Do you know how to read the MACD study? This study will be added to our divergence series. We will discuss how to read MACD and how it should be used. What is the MACD? A “moving average” study presents “convergence and divergence” signals between the Value Line and the average line. As a result, it’s also known as the Moving Average Convergence Divergence. For other divergence studies, you can check out the RSI Divergence Indicator Study and the OnBalanceVolume Indicator Study.

  • Value = MACD Line
  • Avg = Moving average of the MACD Line
  • Diff = Difference between the Value and the Avg
  • Value Line is the value we get when we subtract the 26EMA from the 12EMA

In the picture below, we open the user dialog box for the MACD Study inside ToS and see the signal settings. Let’s take a closer look.

From left to right, we have Value, Avg, and Diff. ZeroLine, UpSignal, and DownSignal are also present, but we can set them aside for now. To better understand how to read MACD, we need to understand what these things are inside this user dialog box.

How to Read MACD User Dialogue Box

Value, Avg, & Diff make up the critical pieces of the MACD Indicator Study.

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Decipher

Now that we have identified what the names represent, we can decipher how to read MACD and what the moving average convergence divergence signals are made of. As a result, the picture below a candle stick chart shows the 26EMA and 12EMA.

The Value Line in the MACD study is nothing more than the value we get when subtracting the 26EMA from the 12EMA.

MACD Moving Averages

The Calculations for the MACD.

How to Read MACD Value Line

The Value Line by itself does not offer many useful signals. However, one signal it does offer alone is the slope or market trend direction. When the Value line is pointed up, the price is on an uptrend. Likewise, if the value line points down, the price is downtrend.

The steeper the slope on the value line, the stronger the trend’s momentum. Remember that the Value Line is derived from two moving averages.

Like moving averages, the Value Line Slope can offer some important clues. A sideways Value line indicates market uncertainty, consolidation, or “ranging patterns.” Use this as a guide on how to read MACD.

How to Read MACD Avg Line

The average line is the Value Line Average. Think about this for a moment. We took the 26EMA value and subtracted the 12EMA value to get the MACD Line.

Now, we have the average line of the MACD Line. Understanding why this is beneficial will help you understand why the MACD study is such a powerful tool and why you need to know how to read MACD, especially when trading low-float stocks.

Averages provide access to the mean. Since NO ONE can predict the market, the best we can do is try to understand what has already happened and try to develop an understanding of what COULD happen next based on the previous data.

An Average of ANYTHING is a great way to visualize where the COMMON ACTION is. To visualize where the “NORMAL” can be found. Once we can identify “normal,” we can begin looking for signals that are not normal.

Crossover Example

Value Line, Avg Line, & Diff Histogram

Histogram

The Diff is presented in the MACD study as a Histogram. The Diff is the measured distance between the Value and average lines.

That may sound confusing when learning how to read MACD; however, it means that instead of presenting Diff as a line (like the Value Line or the Avg Line), the Diff is shown by using Swab Bars.

The picture above shows that the Diff Swabs become shorter when the Value Line converges with the Avg line. When the Value Line and the Avg Line cross over, the Diff Swabs cross over from one side of the Zero Line to the other.

This is because the Diff Line measures the distance between the Value Line and the Avg Line. They have no distance to measure When they touch (during the cross-over).

How to Read MACD Study Default Settings

When learning how to read MACD, the Avg Line has a default setting of 9EMA. If you look back at the picture of the user dialog box, you’ll see a Fast Length, a Slow Length, and a MACD length. We have already shown that the Fast Length default is 12 and the Slow Length default is 26. Now we understand the MACD Length is the length used to measure the average line.

A normal MACD study sets the average line with a default of 9. It is the average of the average convergence or divergence. Perhaps it is time to understand those terms more to understand better how to read MACD.

How to Read Price Action Bullish Divergence

Example of Bullish Divergence

Convergence

The MACD line is the measurement between two moving averages, as presented above. When those two moving averages move toward each other, they converge.

We’ve learned from the Moving Average Blog that when moving averages move toward each other, it signals failing momentum. By measuring this movement towards each other, we can develop some analysis of the strength of the trend presented by the sloped Value Line. As a result, we can better understand how to read MACD.

Bearish Divergence

An example of Bearish Divergence

What Is Divergence?

Again, how to read MACD is the measurement between two moving averages. Divergence is when these two moving averages move away from each other. They are diverging.

The signal is given when two moving averages spread out and move away from each other. By analyzing this movement, we can measure the strength of the presented trend. The slope of the Value line does this.

The Fast Line (shorter moving average or 12EMA) will follow the price more closely than the Slow Line (longer moving average, or 26EMA) when the price makes a sharp move in a direction.

The two moving averages separate because the slower moving average will follow slower. The farther away these two moving averages become, the steeper the slope and the greater the divergence.

Moving Average Cross

The MACD crosses the Zero Line when the 12EMA and 26EMA cross-over

Zero Line Cross-Over

What causes the Value Line to cross over the Zero Line? The Moving Averages on the price chart.

Look at the picture above; you can see that when the 12EMA and the 26EMA cross, the Value Line crosses the zero line. In other words, the MACD crosses the Zero Line.

This gives us a great signal of price reversal since we use moving average cross-overs to signal when the price has changed direction. Hence, it is important to understand how to read MACD.

How to Read MACD Study 2 Lines

When learning how to read MACD, the MACD Study shows two lines and a histogram of the distance between those two lines.

The first line is the Value Line (or the MACD Line). It’s the value of the distance between the 26EMA and the 12EMA. This measurement of the convergence and divergence between these two EMAs is the MACD or value lines.

The EMA of the Value Line is called the Avg Line. The Diff Swab is the measurement between the Value Line and the Avg Line. This is also known as the MACD Line and the MACD Average.

Internal Indicators

The Value Line is a measurement of moving averages on the price chart. The Avg Line and the Diff Swabs are internal indicators and ONLY measure the Value Line. They have nothing to do with price at all. The Avg Line and the Diff Swabs are an indicator of an indicator.

The MACD is not a “GO / NO GO” study that will offer you trade entries and trade exits. The MACD Study is designed to watch for changes in the current market direction. As a result, it signals when the directional momentum is shifting or changing.

That’s it: current direction, impending directional change, and momentum strength of the current market direction. The Value Line shows direction, and the Diff Swabs show momentum.

Hence, knowing how to read MACD is important to trading the indicator.

Example

Review of MACD Value Line, Avg Line, & Diff Histogram

Strategies

We clearly understand how to read MACD and where the signals come from. We may begin developing a few strategies that use these signals.

The different MACD signals are reversals, momentum, and trend. While we’ll focus on the signal analysis of the MACD study, this is a great time to point out that no study or indicator should be used alone. All analysis should include support and resistance, volume, and tape.

Trend Change Signals

The Trend can be defined from a higher time frame

How to Read MACD Study and Define the Trend

The MACD may be used to develop a bias in market direction and determine the trend. As a result, knowing how to read MACD can help define a trend. One way to do this effectively is to apply the MACD on a higher time frame.

As a result, the trend is determined, and then trades that go with said trend. For example, if you trade on the 4-hour chart, you would want to look at the daily chart with the MACD to develop a trend bias.

If you trade on the 1-hour, you want to set the MACD onto a 4-hour chart to determine market bias. The MACD will show trend bias with the Value Line.

You would look for long trades when the Value Line exceeds the Avg Line. However, you would look for short trades when the Value Line is below the average line. Trade with the trend.

Trade the Trend

The MACD offers a glimpse of changing market trends. Long trades should be taken if the Value Line exceeds the Avg Line. Let’s look at that more closely.

This indicator has great swings above and below the Zero Line. The Value Line presents more signals than just being above or below the average line. Look at the slope of the Value line and the length of the Diff Swabs.

This allows us to anticipate upcoming trend changes or develop a contrarian perspective. In the picture below, you can see on the daily chart how the Diff Swabs began to print lower and lower as the Value Line curved over and began to converge.

The average line tells a story of impending market trend change. On these trading days, avoiding trading the stock, using a lower time frame, or anticipating an uncertain market would be good.

As a result of knowing how to read MACD, you can trade the trend and know when to sit out.

Trend Ending

A signal that the trend is ending

Consolidation

If you know how to read MACD, then you know it’s a great tool to identify when price action is range-bound. When looking for an anticipation trade, the MACD can show when volatility is low, price action is consolidating, and momentum begins to build for an explosive move out of the contraction.

The picture below shows where the Diff Swabs leveled off and swapped above and below the Zero Line as the price ranged in a tight pattern. These signals are clear and offer an opportunity to anticipate a move before the breakout.

Consolidation of Price

MACD gives signal that a breakout has begun

Price Action Divergence

The MACD is a great tool to identify price action divergence by looking at the trending Value Line and the trending price. However, I still believe that building a divergence signal into the MACD Indicator Study allows the trader to focus on other factors.

For instance, instead of continuously seeking divergence between price action and the MACD, you can wait for a divergence signal that identifies when divergence has occurred.

A beneficial tip: lower timeline charts have a lot of divergence signals that produce few meaningful results. This tip doesn’t apply just to the MACD but to all divergence studies in lower timelines.

How to Read MACD Study Price Divergence
Bearish Divergence Example

Bullish Divergence

How to Read MACD Failure

The MACD Indicator Study I’ve coded offers Bearish or Bullish Divergence signals when price action and the MACD line disagree. You find them when you know how to read MACD. These divergences allow the trader to develop a stock trading strategy based on an impending change in trend or momentum.

The picture below shows the new MACD Dialog Box with the Bullish and Bearish Divergence user settings. These signals can be turned on or off and appear on the Zero Line when a divergence is detected.

Divergence Dialogue Box
Divergence Example

Divergence Signals will show up on the Zero Line

In Review

This article discusses how to read MACD, divergence, price action, trend direction, and momentum. These common trade tactics are the backbone of a full trading strategy.

It doesn’t matter if you’re a swing trader, day trader, options trader, or even a futures trader; the basic trading tactics discussed in this blog should be familiar. Hence, there is a need to understand 100% before taking a trade.

As a member of the Bullish Bears Community, you’ve paid for access to thousands of dollars worth of education and training. Ensure you take advantage of the value you’ve paid for if you’re serious about stock market trading.

MACD Trade Entry Signals

The MACD is not the tool for entries and exits. I’ve read many blogs suggesting a crossover is a trade entry signal; however, I’m afraid I have to disagree.

One of the great things about being an individual trader is developing our skills, abilities, and opinions about market analysis and trade strategies. The more we learn and grow in our abilities, the better our analysis becomes.

I don’t consider the moving average convergence divergence a trade signal indicator because I don’t consider a moving average crossover a trade entry signal. The signal is too late and has no context.

Can it be used as a signal for entry? However, other tools were designed to give such signals and do a better job. The MACD was not designed to provide entry signals.

Divergence Study Indicator

The ThinkOrSwim MACD study I developed can be added using the Copy / Paste commands. The link is: http://tos.mx/FFw0YX

How to Read MACD Crossover Signals

When you first started trading, you may have heard that moving average crossovers are a great trade entry signal. Much information suggests using the 9EMA and the 20EMA combined or the 8EMA and the 15EMA.

Look back over the charts after the market has closed. Compare the EMA crossovers to the market price action. You may have seen some great opportunities. However, if you tried to trade that strategy in real life, you may have found that there are fake-out signals, failed entries, or changes in direction soon after the crossover.

Using two moving averages as a signal to enter a trade at the crossover is bad. The MACD is nothing more than a measurement of two moving averages. As a result, I’ll say it again: the MACD study is not designed to be a trade entry signal.

Final Thoughts: How to Read MACD

Learn how to read MACD. The MACD is a great indicator that offers a trader’s perspective on the direction of the market trend, the strength, and signals of approaching trend changes or failing momentum.

Market Forecasting is a skill that must be developed by study and practice.

Knowing how to read MACD helps you develop that skill. When added to other charts and market analyses, the MACD Indicator Study provides you with the missing pieces of the puzzle.

While we did not review modifications to the MACD user settings, you now better understand the MACD indicator. As a result, you may begin to research different ways to adapt and develop MACD trading strategies that fit your style.

Frequently Asked Questions

The default MACD settings are (12, 26, 9) which relates to the 12 period exponential weight average, 26 'fast line', and the 9 which is the 'slow line'.

The MACD is a trend reversal indicator, similar to the stochastic oscillator. It provides buy and sell signal lines.

A buy signal happens when the MACD line crosses the signal line. A sell signal happens when the MACD line falls below the signal line.

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