MACD (Average Variable Convergence Divergenence) is a trend following momentum indicator that is widely used by traders. Although the MACD is a slow indicator, it can be very useful in identifying trend changes.

BTC / USDT daily chart | Source: TradingView

The MACD swings above and below the zero line, also known as the center line. The shorter moving average subtracts the longer moving average to get the value of the MACD line and the signal line is the EMA of the MACD line.

The blue line is the MACD and the red line is the signal line. A buy-signal is generated when the blue line crosses the red line, and a sell-signal is generated when the blue line crosses the red line. And when the MACD line crosses the center line (the 0) line, that is also a buy-signal.

Let’s see how you can use the indicator for better entries and exits from different positions. We will then examine how the MACD behaves during a pullback and during an uptrend. Finally, we’ll look at the importance of divergence in MACD.

Adjust the indicator to the volatility of the crypto market

Compared to the stock market, the cryptocurrency market is more volatile in the short term. Therefore, entries and exits, apart from jagged fluctuations, must be recorded quickly.

When a new uptrend begins, it is usually valid for several weeks or months. However, every bullish phase has a periodic correction. Traders should try to hold onto the trend and not let every small pullback stop them along the way.

The goal is to take a position early when the uptrend has just started and stay in that position until a trend reversal signal is displayed. Easier said than done, however. If the indicator gives too many signals, will generate some unwanted transactions and emotionally exhausting.

On the other hand, if the large time frames are chosen to give fewer signals, traders can miss out on a large part of the trend as the indicator slowly detects the turning points.

This problem was addressed by MACD inventor Gerald Appel in his book Technical Analysis: Power Tools for active investor.

Appel highlights two MACD indicators that can be used on strong trends, the more sensitive indicator being used for entries and the less sensitive indicator being used for exits.

Is Using Two MACD Indicators Better Than One?

The default value used for the MACD indicator in most charting software is a 12 to 26 day combination. For the next examples, however, we will use a MACD with a less sensitive combination of 19 to 39 days to find sell signals. The second is more sensitive and uses a combination of 6 to 19 day MACD to find buy signals.

BTC / USDT daily chart | Source: TradingView

Bitcoin (BTC) was trading in a small range in September 2020 and during that time both MACDs were largely unchanged. In October, when the BTC / USDT pair started an uptrend, the MACD gave a buy signal when the indicator broke above the midline in mid-October 2020.

After entering the trade, watch the MACD line approach the signal line four times (marked as an ellipse on the histogram) on the 6- to 19-day combined MACD. This can result in an early exit and miss out on a large portion of the profits on paper as the uptrend is just beginning.

On the other hand, the less sensitive 19- to 39-day combination still suggests stability in the uptrend. This could help traders stay in position until the MACD crosses below the signal line on November 26, 2020 and triggers a sell signal.

Daily BNB / USDT Chart | Source: TradingView

In another example, Binance Coin’s (BNB) MACD line crossed the center line on July 7, 2020, triggering a buy signal. However, the sensitive MACD turned down quickly and fell below the signal line on July 16 when the BNB / USDT pair took a minor correction.

Similarly, the less sensitive MACD will stay above the signal line through August 12, 2020, capturing a larger portion of the uptrend.

LTC / USDT daily chart | Source: TradingView

Traders who are struggling to keep track of the two MACD indicators can also use a 12 to 26 day combination (default). Litecoin (LTC) ‘s journey from around $ 75 to $ 413.49 generated five buy and sell signals. All trades generate very good entry (marked with an ellipsis) and exit (marked with an arrow) signals.

How MACD could signal a correction

Traders can also use the MACD to buy during the pullback. During the correction of an uptrend, the MACD line will fall on the signal line, but when the price resumes the uptrend, the MACD line will bounce off the signal line. This setup is similar to a hook, which can be a good entry point.

Daily ADA / USDT Chart | Source: TradingView

In the example above, the Cardano (ADA) MACD crossed the center line on January 8, 2020, signaling a buy. However, when the bullish momentum stalled, the MACD line sank near the signal line on Jan 26, 2020 but was unable to break it. As the price rebounded, the MACD broke off the signal line and continued to move higher.

This created a buying opportunity for traders who missed buying when the MACD line crossed the center line. The sell-signal was generated on February 16th when the ADA / USDT pair initiated a deep correction.

MACD divergences can also signal a trend reversal

BTC / USDT daily chart | Source: TradingView

Bitcoin price continued to hit higher highs between February 21, 2021 and April 14, but the MACD hit lower highs and formed a bearish divergence during that period. This is a sign that the uptrend is weakening.

Traders should be careful when the MACD forms a bearish divergence and not long trades during such a period. The persistent bearish divergence culminated in a large pullback in this case.

LTC / USDT daily chart | Source: TradingView

Litecoin shows how the MACD formed a bullish divergence during the sharp downtrend from July to December 2019. Traders who bought when the MACD crossed the mid-line in September and November suffered long losses.

This suggests that traders should wait for price action to show signs of changing direction before reacting to MACD divergences.

A couple of important things

The MACD indicator can help traders identify trends and measure the dynamics of an asset. Depending on market conditions and the assets being analyzed, traders can change the time setting of the MACD. Traders can also use a combination of the less sensitive and the more sensitive MACD for better results.

However, no indicator is perfect. Even with the above changes and combinations, trades can go against expectations.

Traders should implement the principles of capital management, reduce losses quickly and protect paper profits when trading is going as it should.

Disclaimer: This article is for informational purposes only, not investment advice. Investors should research carefully before making a decision. We are not responsible for your investment decisions.

SN_Nour

According to Cointelegraph

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