How To Trade The MACD Histogram Indicator
There’s a difference (Part 1)
I’ve specifically titled this article… what it is, because there isn’t just one MACD indicator or at least one way to use it. Most of the pictures of the MACD you’ll probably see have a zero-line (Explained further down), histograms and two moving averages and are not what I’m about to show you. Let me Explain
Moving Average Convergence Divergence is what MACD stands for. You might want to look those words up but to “Converge” means “to meet at a point” usually referring to lines. To “Diverge” means “to separate from”. I would not explain this if it was not important so why is this important to understand?
Because The MACD indicator is a momentum indicator, and when momentum SHIFTS the MACD indicator will quite literally paint a picture of one of the two scenarios. WARNING: The MACD does not indicate new trends. If you trade it trying to predict the start of new trends you will lose your shirt!
Here’s what you are probably used to seeing:
Example 1 (Source – TradingView)
The above example shows you what a MACD indicator usually looks like. This is the genesis baby! Or at least the status quo.
The MACD has 3 numbers that it uses for its settings. The first is the faster MA(Moving average), usually “12”. The second MA, usually “26”. The third is the number of price bars used to calculate the DIFFERENCE between the 2 MAs. If you look at example 1, you’ll see that anytime the BLUE line crosses the RED line, the histogram changes from Red to Green and Vice versa.
Example 1B (Source – TradingView)
To break this down further to see what the MACD is actually doing/calculating (because any indicator is just an equation) in Example 1B we’ve added the matching Moving Averages (12 and 26) onto the price chart.
To kick start this bad boy we would have to recognize that at the far right the MACD has a “zero-line”. The point at which the red histograms become green is the zero-line. To see where this zero-line comes from we will look at the MAs on the price chart. At point “1” we see the 12 MA cross over the 26 MA and at that exact instant, the blue line on the MACD crosses zero.
This means that the SLOWER MA IS the zero-line and if you follow this logic through the chart we find that to be true when at point “2” the 12 MA crosses back above the 26 MA at the same time that blue MACD line crosses back over the zero-line. The MACD histograms show the difference between MAs on the MACD. The Blue line shows the difference between the MAs on the price chart. That’s the difference!
Which brings me to how I use the MACD. I simply remove the MACD histograms and use the blue MACD line in the form of a histogram. Check out what I mean below…
Example 2 (Source – TradingView)
See? If you look at Example 1 again, you could literally trace the blue MACD line onto these histograms. The reason I use this MACD is that I was taught with it. Most of you were probably taught with the setup in Example 1 which, if you’ve understood, we don’t really need for what I’m about to show you.
How to Trade Convergence and Divergence
Let’s address the elephant in the room. How do you make money trading with the MACD? If you’re here I’m hoping you haven’t skipped all the important information before. If you’ve eaten your veggies, let’s get to the steak… or chickpea (If that’s your vibe).
There’s nothing wrong with using the MACD as a reversal indicator, so long as you use it to find the end of a retracement inside a trend in an attempt to trade in the direction of the trend and not to find the end of the entire trend. Convergence and Divergence usually mean the end of something. In the right context MACD can be very successful in calling reversals, but remember nothing is a guarantee in this game. Let’s see what an example of Convergence/Divergence could look like.
Example 3 (Source – TradingView)
In Example 3, we see the yellow lines drawn on the chart clearly indicate to us that price is making lower lows but the MACD is making higher highs. If we take those yellow lines and extend them, they will CONVERGE which means to meet at a point. This means that there is a momentum imbalance and price could (No guarantees) go the other way.
You will notice price made a lower low twice before changing direction. This is why it is important to try and follow the trend because there will be less resistance. Although this occurrence called a reversal on a down-trend, this won’t always be the case.
Example 3B (Source – TradingView)
Above we have examples of Divergence. Similarly, if we extend the yellow lines at either occurrence they will DIVERGE which means to separate from. At 3b we see what happens when you trade against the trend. The market did reverse for a short while but continued to trend. And only at 3c, did price and momentum diverge causing the trend to end. If you intend to trade the reversal signals at any and every point, my good sir/madam you better have a money management strategy from the gods themselves.
The MACD is a powerful tool you can use to identify a shift in momentum and Po-ten-ti-al reversal alright kids. I wouldn’t recommend messing with the settings either, on your live account anyway. This is the chicken nugget right here: I’ve found the MACD to be powerful when price is retesting an area and the momentum is just not there. The MACD could really work well with your double tops and double bottoms to weave out some losers which is the same as getting more wins.
Don’t bet the farm.
Don’t lose your shirt.
Cut the L.
Keep the W.