The volatile crypto world is a playground for learning and using different technical analysis indicators. Perhaps the most helpful variety for the newcomer is lagging indicators, or indicators based on past price movements.
These give a sense of history to your analysis and point directly to emerging trends in both bull and bear markets. We’re going to take a brief look at one of the more information-dense indicators that can be used to predict future price movement – the moving average convergence/divergence oscillator, or MACD indicator.
This indicator can be used in conjunction with other confirmation methods to predict future bull and bear runs using historical information.
Components of the MACD
A MACD chart consists of three main components. There will be a line indicating the 12-day exponential moving average, a line indicating the 26-day exponential moving average, and a series of bars that indicate the difference between the two.
You might also find MACD charts that use a 12-day exponential moving average and a 9-day average of that line, called the MACD line and the signal line, respectively. In either case, the charts are read in the same way. We’re going to focus on the 12-day, 26-day version for simplicity.
Image from Investopedia
An exponential moving average provides a snapshot of prices over time, weighted toward more recent prices via a rather complicated algorithm. A 12-day moving average displays the weighted average over the past 12 days, and the 26-day moving average displays the weighted average over the past 26 days.
The 12-day moving average can be thought of as a short-term indicator of market sentiment and direction. The 26-day moving average is not quite long enough to be called a long-term indicator, but it provides an important counterpoint to the 12-day moving average.
For our purposes, we’ll refer to the 12-day moving average as a short-term indicator and the 26-day moving average as a medium-term indicator.
As these moving averages flow along the chart, distance will develop between their respective peaks and troughs. They might cross over each other, and they might follow in parallel.
The bars at the bottom of a MACD graphically represent the distance between the lines and their relative direction. Bars pointing upward indicate that the short-term moving average is above the medium-term moving average and vice versa for downward-pointing bars.
Image from Investopedia
Contained within these three components are all the information you need to confirm a bullish or bearish run in the near future.
How It’s Used
Reading a MACD chart is relatively straightforward.
The first thing to consider is the slope of the chart in general. If both lines are sloped up, then the market is in a general bull run. If the lines are sloped down, then the market is retreating and is in the midst of a bear run.
The interesting part comes in when you consider the distance and direction of the lines from each other.
Like other varieties of moving average charts, when the short-term moving average is above the medium- or long-term moving average, sentiment is good and the price can be expected to rise. The degree to which this is the case can be measured by the lines at the bottom of the chart. Long, upward-point lines indicate a healthy distance between the short- and medium-term moving averages. Practically, this means that short-term prices are outperforming their medium-term equivalents.
It’s worth noting that this is only a snapshot of the market as it immediately stands, and the prices can’t be extrapolated long term. For example, a wide divergence in an upward direction between short- and medium-term prices might mean that the market is on its way to being overbought. Conversely, if the lines are long and point downward, you can infer that the market is in a downward trend but might very well be on the way to being oversold.
In both scenarios, what you’re looking for is a crossover of the lines. This indicates a trend reversal and can be used to plan future trades.
If the short-term moving average crosses the medium-term moving average from above – putting it below the medium-term moving average line – that tells us that pricing sentiment has tanked and the market is experiencing pullback. If it crosses from below and travels above the medium-term moving average, sentiment has perked up and we should expect price increases in the near future.
Image from Investopedia
As is always the case with lagging indicators, it’s always a good idea to doublecheck your work with a different technical analysis indicator to confirm the overall trend. Moving averages alone shouldn’t be used to forge pricing positions or buy-in levels.
Limitations of the MACD Indicator
The first and most obvious drawback of the MACD indicator is that the settings can differ from user to user. We’ve already discussed the 12- and 26-day moving average version vs. the 12- and 9-day version. These differences can mean that two different MACD users might get different readings from the same data, depending on which version they choose to use.
The timeline of the chart may also muddle the data. Most traders prefer to use the MACD indicator on a daily price chart. It’s helpful, however, to confirm trends across wider timelines to avoid noise in the short-term numbers. Always remember that when you’re dealing with moving averages, you’re already dealing with a time component that was designed to smooth out choppy day-to-day pricing information. Be careful that you don’t smooth your lines out to the point of being uninformative.
Since the MACD is a lagging indicator, it can be somewhat slow to register sudden shifts in the market. This is particularly pertinent to the wild and woolly world of cryptocurrency, where major swings can happen in a matter of hours or minutes. Relying solely on an MACD indicator analysis will leave you a step behind the market itself.
Finally, an MACD might produce a false reversal signal if the trader acts too quickly. Markets frequently tiptoe along the reversal line, vacillating back and forth before making the actual plunge. Because the MACD is a lagging indicator, you run the risk of jumping the gun, so to speak, on a reversal before that reversal really takes hold.
For example, if the MACD shows a crossover indicating a coming bull run and you act on it too quickly, you might overextend yourself before the market truly begins the run. Again, it’s helpful to confirm price moves and reversals with several different indicators before actually placing trades.
More Technical Analysis Guides
We have also created a number of guides about Technical Analysis :
- Day Trading Cryptocurrency Guide
- Cryptocurrency Trading: What Are Bollinger Bands ?
- Cryptocurrency Trading: Head & Shoulders Trading Patterns Explained
- Cryptocurrency Trading: Momentum Indicators and Moving Averages
- Cryptocurrency Trading: What is Margin Trading ?
- Cryptocurrency Trading: Identifying and Using Fibonacci Retracement Levels
Another Tool in the Box
The MACD is a helpful tool for determining future price direction using lagging indicators. The main things to keep an eye on are the short- and medium- term moving averages. Ideally, you want the short-term moving average to stay above the long-term moving average, unless you plan to take a short position.
Keep an eye on the histogram at the bottom of the chart for overbought and oversold indicators and pay special attention to crossovers. Also, keep in mind that you’re working with essentially old data.
It pays to doublecheck your work with a variety of indicators to confirm that the price action you’re seeing on the MACD is actually taking place.