How to Use the MACD Histogram as a Technical Indicator
The convergence and divergence of moving averages can be a very powerful technical indicator. The MACD (Moving Average Convergence/Divergence) is a trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the "signal line", is then plotted on top of the MACD, functioning as a trigger for buy and sell signals. Like any technical indicator, it is just another tool in your trade analysis tool box. It is not a silver bullet indicator, and you should not trade blindly using only MACD.
MACD measures the difference between the two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate of change of the faster moving average is higher than the rate of change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average and the slower moving average is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD center line crossovers occur when the faster moving average crosses the slower moving average.
The most commonly used way to trade the MACD is crossovers. The idea is to buy the when the fast line crosses above the signal line (bullish crossover) and sell (or short) it when the fast line crosses below the signal line (bearish crossover). There are two things to note about using MACD crossovers. First of all, like other moving average crossovers, they work well in trending markets. The problem with this crossover system is that you get a lot of false (i.e. losing) signals in choppy markets. In general, MACD crossovers don’t work. Mechanically trading MACD crossovers is a recipe for disaster, especially in choppy or sideways markets. MACD crossovers can be useful when combined with other tools, but none of the professional traders I’ve ever talked with uses MACD crossovers.
While crossover trading is a poor strategy, the MACD histogram can still be used as a very powerful trading tool. A good friend, and fellow professional trader has put together a brief 22 page PDF document outlining a very effective MACD histogram trading strategy. The strategy is easy to follow and includes plenty of example charts so you can visualize how it works. We're offering copies of this PDF to our users at no cost. If you'd like to get a free copy of, "How to Trade with MACD Histograms", fill out the form below: