MACD anticipates 〇〇
A Question on the Essence of MACD
“MACD is an indicator that looks at the spacing between two moving averages, but its formula uses EMA. Explain why EMA is better than SMA.”
The definition of MACD is
MACD = short-term EMA − long-term EMA
Therefore, you cannot understand MACD without understanding EMA.
Do you know the definition of EMA?
Also, when MACD is displayed on a normal chart, the default shows
・MACD line
・Signal
・Histogram
which can make the discussion somewhat confusing.
In this article, we will focus only on the MACD line.
If you understand the meaning of the MACD line, you will naturally understand the meanings of the signal and histogram as well.
Answer
“EMA responds to price faster and more smoothly than SMA, making it easier to anticipate a Golden Cross.”
Explanation
Originally, when MACD was developed, there was only one MACD line.
Nowadays, the entire trio—MACD line, signal, and histogram—is collectively called MACD and treated as a technical indicator.
By the way, the signal is a moving average, and the histogram is a vertical bar chart.
This time we will explain why the MACD line was developed.
Display two moving averages and the MACD line
There is a famous buy signal in trading signals called the Golden Cross.
Why is the Golden Cross considered a buy signal?
Crossing of the two moving averages constitutes buy and sell signals, but when you look at a chart, you might wonder:
“Can I act sooner?”
In the Golden Cross, prices tend to rise to cause the two lines to intersect, so you end up buying at a relatively high price.
If the two lines are about to cross, you might want to enter before the cross to trade at a favorable price.
A crossing occurs when the gap between the two lines becomes zero. Therefore, if you can tell that this gap is likely to close soon, you could buy before the Golden Cross occurs.
MACD’s definition is
MACD = short-term EMA − long-term EMA
In the chart above, the commonly used MACD settings are
short-term 12 days and long-term 26 days,
the red line is the 12-day EMA
the blue line is the 26-day EMA.
In the white circle area, you can see that MACD moves upward toward the 0 line before the Golden Cross occurs.
In other words, crossing of the two lines = MACD reaching 0
.
MACD moving from negative to crossing the 0 line and turning positive means prices are rising, the two lines cross, and the gap between the two lines eventually widens.
By watching the gap between the two lines, you can anticipate whether a Golden Cross or Dead Cross will occur, which is the function of MACD.
Now, why is EMA better?
When you try to predict the crossing of the two lines, if the gap between them widens and narrows erratically, it becomes hard to foresee.
If the gap gradually narrows stably, it becomes easier to anticipate that the two lines will cross in the future.
If the lines are jagged, there will be more false signals, as the two lines may touch and then separate again.
Therefore, EMA, which moves more smoothly than SMA, is better.
The origin of the MACD name is
Moving
Average
Convergence
Divergence
Moving Average means moving average
Convergence means convergence
Divergence means divergence
In Japanese, MACD stands for Moving Average Convergence/Divergence, a formidable name.
Because it is an indicator that observes the separation between two moving averages, when displaying MACD, show it together with two EMAs.
Once you understand the meaning of the MACD line, you should also understand why the signal and histogram exist.
Since the MACD line foresaw the crossover of the two moving averages, the histogram is meant to foresee the crossover between the MACD line and the signal?
Please think about this on your own.
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