MACD Indicator Explained: Best Settings & Trading Strategy Tested

Over 20 years, a buy-and-hold investor would have made 39,975% with Apple, but a MACD trader would have made only 961%. Only 40% of MACD trades were profitable, and the spread between winning and losing trades was 0.2%. No, the MACD indicator is inaccurate; it causes many small losses and misses good entry points. Backtesting the MACD indicator on 30 Dow Jones Industrial Average stocks over 20 years resulted in a 26% win rate, meaning it underperformed a buy-and-hold strategy 76% of the time. Another advantage of the MACD is it can be a relatively simple indicator.

  1. Some traders that utilize this strategy wait for a “trigger,” or some sort of confirmation of the divergence.
  2. The MACD can help you identify both the signal line crossover and the zero line crossover with relatively high accuracy.
  3. Gerald Appel developed MACD in 1979 as a trend-following indicator to determine the momentum of an asset.
  4. Looking at the E-mini S&P 500 future, from High #1 to High #2, the futures contract made higher highs, which is usually viewed as bullish.
  5. A cross of the MACD’s zero line is the same signal as a chart with two exponential moving averages.
  6. If a trader entered a long position when the MACD crossed from below, they would be left with a losing stock if prices continued to fall.

Traders often try to employ this indicator to identify potential entry and exit points in a market. The Moving Average Convergence Divergence (MACD) is a widely used yet poorly performing technical analysis indicator. Traders are misled into believing they can profit from this indicator. Using the power of TrendSpider’s backtesting engine, we can scientifically test the accuracy and success rate of the MACD indicator and the optimal settings. As a centered oscillator, the MACD does not have any upper or lower limits to its range. Because of this, the MACD doesn’t provide precise overbought and oversold readings.

Read on to learn about moving average crossovers, buy and sell signals, the MACD histogram, and divergences. MACD is based on EMAs (more weight is placed on the most recent data), which means that it can react very quickly to changes of direction in the current price move. Crossovers of MACD lines should be noted, but confirmation should be sought from other technical signals, such as the RSI, or perhaps a few candlestick price charts. Further, because it is a lagging indicator, it argues that confirmation in subsequent price action should develop before taking the signal. MACD is a valuable tool of the moving-average type, best used with daily data.

The difference between the MACD line and a second signal line is then plotted as an easy-to-interpret histogram. When the shorter-term 12-period exponential moving average (EMA) crosses over the longer-term 26-period EMA a potential buy signal is generated. Traders will often combine this analysis with the RSI or other technical indicators to verify overbought or oversold conditions. MACD should be combined with other chart indicators, such as Price Rate of Change or bullish chart patterns. For example, most indicators perform well when a stock is trending either up or down.

Indicators that work with MACD

Over 20 years, MACD lost to a buy-and-hold strategy on 74% of the Dow Jones Industrial Index stocks by a significant margin. The MACD uses three moving averages to create a trading signal – the faster 12-period EMA, the slower 26-period EMA, and a 9-period EMA that signals the direction of the MACD line. Traders can use the MACD line to identify potential trends, but the MACD line can provide even more information after applying the signal line. A signal line is the 9-day EMA of the MACD line, which is then plotted on top of the MACD line on the histogram. When the 12-day EMA crosses over the 26-day EMA, the MACD generates a potential buy signal and vice versa. The accuracy of an indicator is subjective and varies based on many factors.

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Divergence takes place when both are moving away from each other, while Convergence occurs when they are getting closer. The MACD indicator can help you spot powerful signals like a crossover or a divergence. Learning to use it for accurately predicting the formation of new trends will significantly improve your trading.

The comparison is done by using a simple moving average (SMA) to smooth the results out. Moving average convergence divergence (MACD) is one of the most popular technical indicators in trading. The MACD is appreciated by traders worldwide for its simplicity and flexibility, as it can be used as a trend or momentum indicator and signal opportunities to enter and exit positions. The Moving Average Convergence Divergence (MACD) is a momentum oscillator that reveals changes in the strength, direction, momentum, and duration of a trend in a stock’s price. The MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.

This suggests bullish momentum is increasing and could be used as a buy signal. On the contrary, when the MACD Line falls faster than its signal line, the histogram bars will move below zero, a bearish signal indicating potential selling opportunities. From backtesting to production trading, traders can test multiple strategies through a blend of Lime’s feeds to the exchanges and live data feeds. The zero-cross strategy could be used again to take a long position when the MACD crosses the zero line from below. At the point circled in our image, prices have been rising and momentum is up. Keep in mind, though, that the histogram doesn’t come without its faults.

The default values are (12, 26, and 9) – 12 for the shorter EMA, 26 for the longer EMA, and 9 for the signal line. Depending on the trading software, as you are moving through the chart, on the right, you can also see their current values. On a chart, the MACD is visualized as two lines, oscillating without boundaries.

What is the difference between MACD and RSI?

This is often seen as the slowest signal of the three, so you will typically see fewer signals, but also fewer false reversals. The strategy is to buy – or close a short position – when the MACD crosses above the zero line, and sell – or close a long position – when the MACD crosses below the zero line. Another MACD drawback is its inability to make comparisons between different securities. Because the MACD is the dollar value between the two moving averages, the reading for differently priced stocks provides little insight when comparing a number of assets to each other. As mentioned earlier, the MACD indicator is calculated by taking the difference between a short-term moving average (12-day EMA) and a longer-term moving average (26-day EMA). Given this construction, the value of the MACD indicator must be equal to zero each time the two moving averages cross over each other.

In addition, I tested it against more robust indicators such as RSI and Stochastic Oscillators. The best way to use the MACD indicator is with other tools that may give a confirmation signal when using it alone could lead to false signals and unnecessary losses. This backtesting example shows that MACD failed to beat a buy-and-hold strategy on Visa’s stock chart. A buy-and-hold investor would have made 1366%, whereas a trader would have made only 81%. The average win was 6.16%, and the average loss was 3.7%; these margins are too tight. Testing the standard MACD settings on a daily candlestick/OHLC chart proves this indicator is poor, with 29 (97%) of the 30 DJIA stocks failing to beat a buy-and-hold strategy.

Furthermore, false positive divergences often occur when the price of an asset moves sideways in a consolidation, such as in a range or triangle pattern following a trend. Again, double-check the ADX to determine whether best japanese stocks a trend is in place and also look at what price is doing before acting. These indicators both measure momentum in a market, but because they measure different factors, they sometimes give contrary indications.

The explanation here is very simple – if the histogram is moving upward, you have a bullish signal, and you can buy. In that case, if they are getting smaller, it means the bears are weakening. However, make sure to buy only when the bars get above the zero line, although the more aggressive traders don’t always wait for such confirmation and act on the first signal. To completely understand what the Moving Average Convergence Divergence is, we should also take a look at the reason why it is so popular among traders.

When using the zero cross strategy, it is crucial to understand where to exit the market, or place a stop. The market in the below example provides several trendline breaks, which would have signalled a good time to exit the trade. Alternatively, a trader could use a break below the previous swing low (uptrend) or above the prior swing high (downtrend) to exit the trade. This is a leading strategy, in contrast to the lagging crossover strategy mentioned above. The histogram reversal is based on using known trends as the basis for placing positions, which means the strategy can be executed before the market movement actually takes place.

Just as with most technical indicators, using the MACD is a blend of art and science. Experiment with it first to decide how it might play into your buying/selling strategy. If you struggle to understand the MACD indicator simply by looking at both lines, then you can use the histogram instead.

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