What is the MACD Indicator
First thing’s first, I like to always talk about the indicator itself before talking about how to use it.
Because, if you do not understand how the numbers, the lines are derived on the indicator, it won't make much sense later on!
This is why we always go back to fundamentals.
What is a MACD?
The MACD indicator has three parts to it.
Let me explain to you what they are…
This line is derived right by taking the 12-day exponential moving average minus the 26-day exponential moving average!
This is where you get the MACD line based on this calculation!
The signal line is simply the 9-day exponential moving average of the MACD line.
The MACD histogram is where you just take the MACD line minus the signal line.
So, that’s the math behind it, and if it sounds confusing, don't worry.
Because I'm going to illustrate it with a chart right now so everything will be crystal clear.
So over here, you can see that this is the MACD indicator:
I'm going to just walk you through what they are.
The orange line is the signal line and the blue line is the MACD line!
The red thing and the greenish thing that you see is called the MACD histogram.
Let's understand how the indicator goes up and down.
If you recall the MACD line, it's just the 12-day EMA minus the 26-day EMA.
So, if you want to see, I've got a 12-day EMA (blue line) and the 26-day EMA (red line) over here:
Right now the value of this blue line is the MACD line is about -17.28
How did I get that?
If you just take the blue line, find out what is its latest value minus the value of the red line.
That's how we get the MACD line.
What about the signal line?
Well, the signal line is quite straightforward.
Recall, the signal line is simply the 9-day EMA of the MACD line.
To put it simply, it's just simply the average of the nine values of the line!
So right now, we got 10 numbers, right?
5, 10, 20, 13, 14, 15, 7, 8, and 10.
What you'll do is that you calculate all these numbers, you add all of this up, and you divide by nine.
And the answer will be the value of your signal line.
Because the signal line is just simply the 9-period moving average of your MACD line.
Simple as it is right?
So, that's how you get the orange line.
And finally, how would you get the value of histogram.
The histogram, if you recall, is simply the MACD line minus the signal line:
One thing to share with you is that the histogram measures the momentum in the market.
You can see that the space between the MACD line and the signal line getting wider is why your histogram starts to slope up.
When the space between the MACD and the signal line starts to tighten, this is where you notice the histogram starts to slope down.
That’s pretty much all there is to the MACD indicator.
Now you know how the numbers are derived, right?
You can actually use the indicator for different purposes as to what I'm going to share with you right now, okay?
The basics are covered, so let's move on…
Generally, the MACD histogram is a trend following indicator and a momentum indicator.
It can measure momentum using the histogram
So, let's talk about how you actually measure momentum and identify a reversal in the markets.
Just to share with you briefly.
Let's say, whenever you are trading support and resistance, the market is in a range.
And you know that you want to sell at resistance.
Whenever the price is at resistance, it doesn't mean you go short immediately.
Instead, you want to see how the price approaches resistance.
For me personally, I like to see a very strong bold and clean move coming into resistance.
I like to see strong momentum coming into resistance where you see large-bodied candles:
Why is that?
The reason is simple…
When you get a strong move up higher, the reversal can swiftly turn towards the downside.
What you don't want to see is that the market chops all the way up and hover around resistance:
This isn’t the type of price action that I don't want to short resistance because it shows that there is a sign of strength.
Market making a series of higher highs and higher lows!
I want to see a strong, bold, and clean move coming into resistance.
Now the question is…
How do you define this strong momentum move?
This is where the MACD comes into play: