What is the Moving Average Convergence / Divergence?
The Moving Average Convergence / Divergence (MACD) indicator is a momentum oscillator popularly used by day traders and swing traders to trade trends. Although the MACD is an oscillator, it is not typically used to identify overbought or oversold conditions. The MACD appears on the chart as two lines which oscillate without boundaries, which gives traders a similar feel to a two/three moving average charting system. If you would like to try the latter on your chart analysis, click ‘Easy Loot Golden / Death Cross’ and favorite this in order to add it to your TradingView list of indicators.
The Moving Average Convergence / Divergence (MACD) is considered bullish when the line is crossing above zero, while bearishness is when the line is crossing below zero. Let’s move onto at this next section where we explain the math formula behind the pretty indicator.
Moving Average Convergence / Divergence Formula
MACD = 12-Period EMA – 26-Period EMA
MACD is calculated by subtracting the long-term EMA (26 periods) from the short-term EMA (12 periods). An exponential moving average (EMA) is a type of moving average (MA) that places a greater weight and significance on the most recent candlesticks.
The exponential moving average is also referred to as the exponentially weighted moving average and it reacts significantly more to recent price fluctuations than a simple moving average (SMA), which applies an equal weight in the specified time frame.
Example of MACD
Looking at this example of Bitcoin (BTC) on the Weekly (1W) time frame we can see the entire price movement over the course of the past 3 years in a clear and concise manner. Off the bat, it is evident that we are looking at a cycle top going into the end of 2017 as well as a heavy period of accumulation as the selloff / great bear market of 2018 took place until we finally broke out at the end of 2020.
Now adding the MACD into the equation of making my best-informed trading decision, during the entire year of 2017 there was a granular rise until the peak hit around the same week that Bitcoin peaked. From the top of the MACD, the next time it surpassed those levels found in 2017 was around the same time that Bitcoin surpassed its previous all-time highs, 3 years later. Its safe to say that on larger time frames, there is a high correlation between the rise / fall in the MACD and the price of the underlying asset, in this case I used Bitcoin.
MACD vs. RSI
The relative strength index (RSI) aims to signal whether a market is overbought or oversold in accordance with the most recent candlestick movements. The RSI is an oscillator that calculates average price gains and losses over a given time frame.
The Moving Average Convergence / Divergence (MACD) measures the relationship between two estimated moving averages (EMAs), while the RSI measures the change in price in relation to the local highs and lows. These two indicators are very commonly used by day traders and are often used in tandem to provide a better insight for the analyst to make an informed trading decision.
These two indicators measure momentum in the market, but because they measure different variables, they sometimes contradict each other. An example of this is the RSI showing a reading above 70, indicating the asset is oversold and looking for a pullback, while at the same time the MACD indicates the market is still going to increase as the bullish sentiment is heating up. This leads us into the next section where we explain the limitations of the MACD, as you shouldn’t base your trades solely on this indicator alone, or in tandem with the RSI.
Limitations of MACD
One of the main problems with the moving average convergence / divergence is that it can commonly signal a possible reversal but then the markets reflect the exact opposite. You can’t justify entering a position from reading the indicators and should always double and triple check your support & resistance levels, trend lines, and profit targets in order to make the best-informed trading decision.