MACD-Histogram Drawbacks

The MACD-Histogram is an indicator of an indicator or a derivative of a derivative. The MACD is the first derivative of the price action of a security, and the MACD-Histogram is the second derivative of the price action of a security. As the second derivative, the MACD-Histogram is further removed from the actual price action of the underlying security. The further removed an indicator is from the underlying price action, the greater the chances of false signals. Keep in mind that this is an indicator of an indicator. The MACD-Histogram should not be compared directly with the price action of the underlying security.

Because MACD-Histogram was designed to anticipate MACD signals, there is a temptation to jump the gun. The MACD-Histogram should be used in conjunction with other aspects of technical analysis. This will help to alleviate the temptation for early entry. Another means to guard against early entry is to combine weekly signals with daily signals. Of course, there will be more daily signals than weekly signals. However, by using only the daily signals that agree with the weekly signals, there will be fewer daily signals to act on. By acting only on those daily signals that are in agreement with the weekly signals, you are also assured of trading with the longer trend and not against it.

Be careful of small and shallow divergences. While these may sometimes lead to good signals, they are also more apt to create false signals. One method to avoid small divergences is to look for larger divergences with two or more readily identifiable peaks or troughs. Compare the peaks and troughs from past action to determine significance. Only peaks and troughs that appear to be significant should warrant attention.

MACD-Histogram Benefits

The main benefit of the MACD-Histogram is its ability to anticipate MACD signals. Divergences usually appear in the MACD-Histogram before MACD moving average crossovers do. Armed with this knowledge, traders and investors can better prepare for potential trend changes.

The MACD-Histogram can be applied to daily, weekly or monthly charts. (Note: This may require some tinkering with the number of periods used to form the original MACD; shorter or faster moving averages might be necessary for weekly and monthly charts.) Using weekly charts, the broad underlying trend of a stock can be determined. Once the broad trend has been determined, daily charts can be used to time entry and exit strategies. In Technical Analysis of the Financial Markets, John Murphy advocates this type of two-tiered approach to investing in order to avoid making trades against the major trend. The weekly MACD-Histogram can be used to generate a long-term signal in order to establish the tradable trend. Then only short-term signals that agree with the major trend would be considered.

After the trend has been established, MACD-Histogram divergences can be used to signal impending reversals. If the long-term trend was bullish, a negative divergences with bearish centerline crossovers would signal a possible reversal. If the long-term trend was bearish, traders would watch for a positive divergences with bullish centerline crossovers.

On the IBM weekly chart, the MACD-Histogram generated four signals. Before each moving average crossover in the MACD, a corresponding divergence formed in the MACD-Histogram. To make adjustments for the weekly chart, the moving averages have been shortened to 6 and 12. This MACD is formed by subtracting the 6-week EMA from the 12-week EMA. A 6-week EMA has been used as the trigger. The MACD-Histogram is calculated by taking the difference between MACD (6/12) and the 6-day EMA of MACD (6/12).

1. The first signal was a Bearish Moving Average Crossover in January, 1999. From its peak in late November, 1998, the MACD-Histogram formed a Negative Divergence that preceded the Bearish Moving Average Crossover in the MACD.
2. The second signal was a Bullish Moving Average Crossover in April. From its low in mid-February, the MACD-Histogram formed a Positive Divergence that preceded the Bullish Moving Average Crossover in the MACD.
3. The third signal was a Bearish Moving Average Crossover in late July. From its May peak, the MACD-Histogram formed a Negative Divergence that preceded a Bearish Moving Average Crossover in the MACD.
4. The final signal was a Bullish Moving Average Crossover, which was preceded by a slight Positive Divergence in the MACD-Histogram.

The third signal was based on a Peak-trough Divergence Two readily identifiable and consecutive lower peaks formed to create the divergence. The peaks and troughs on the previous divergences, although identifiable, do not stand out as much.

Pros and Cons of the MACD

Since Gerald Appel developed the MACD, there have been hundreds of new indicators introduced to technical analysis. While many indicators have come and gone, the MACD has stood the test of time. The concept behind its use is straightforward, and its construction is simple, yet it remains one of the most reliable indicators around. The effectiveness of the MACD will vary for different securities and markets. The lengths of the moving averages can be adapted for a better fit to a particular security or market. As with all indicators , MACD is not infallible and should be used in conjunction with other technical analysis tools.

MACD-Histogram

In 1986, Thomas Aspray developed the MACD-Histogram. Some of his findings were presented in a series of articles for Technical Analysis of Stocks and Commodities. Aspray noted that MACD's lag would sometimes miss important moves in a security, especially when applied to weekly charts. He first experimented by changing the moving averages and found that shorter moving averages did indeed speed up the signals. However, he was looking for a means to anticipate MACD crossovers. One of the answers he came up with was the MACD-Histogram.

MACD Drawbacks

One of the beneficial aspects of the MACD is also one of its drawbacks. Moving averages, be they simple, exponential or weighted, are lagging indicators. Even though MACD represents the difference between two moving averages, there can still be some lag in the indicator itself. This is more likely to be the case with weekly charts than daily charts. One solution to this problem is the use of the MACD-Histogram.

MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to identify levels that historically represent overbought and oversold levels, MACD does not have any upper or lower limits to bind its movement. MACD can continue to overextend beyond historical extremes.

MACD calculates the absolute difference between two moving averages and not the percentage difference. MACD is calculated by subtracting one moving average from the other. As a security increases in price, the difference (both positive and negative) between the two moving averages is destined to grow. This makes its difficult to compare MACD levels over a long period of time, especially for stocks that have grown exponentially.

MACD Benefits

One of the primary benefits of MACD is that it incorporates aspects of both momentum and trend in one indicator. As a trend-following indicator, it will not be wrong for very long. The use of moving averages ensures that the indicator will eventually follow the movements of the underlying security. By using Exponential Moving Averages (EMAs), as opposed to Simple Moving Averages (SMAs), some of the lag has been taken out.

As a momentum indicator, MACD has the ability to foreshadow moves in the underlying security. MACD divergences can be key factors in predicting a trend change. A Negative Divergence signals that bullish momentum is waning, and there could be a potential change in trend from bullish to bearish. This can serve as an alert for traders to take some profits in long positions, or for aggressive traders to consider initiating a short position.

MACD can be applied to daily, weekly or monthly charts. MACD represents the convergence and divergence of two moving averages. The standard setting for MACD is the difference between the 12 and 26-period EMA. However, any combination of moving averages can be used. The set of moving averages used in MACD can be tailored for each individual security. For weekly charts, a faster set of moving averages may be appropriate. For volatile stocks, slower moving averages may be needed to help smooth the data. Given that level of flexibility, each individual should adjust the MACD to suit his or her own trading style, objectives and risk tolerance.

MACD Bullish Signals

MACD generates bullish signals from three main sources:

1. Positive Divergence
2. Bullish Moving Average Crossover
3. Bullish Centerline Crossover

Positive Divergence

A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher Lows or a second Low that is higher than the previous Low. Positive Divergences are probably the least common of the three signals, but are usually the most reliable, and lead to the biggest moves.

Bullish Moving Average Crossover

A Bullish Moving Average Crossover occurs when MACD moves above its 9-day EMA, or trigger line. Bullish Moving Average Crossovers are probably the most common signals and as such are the least reliable. If not used in conjunction with other technical analysis tools, these crossovers can lead to whipsaws and many false signals. Bullish Moving Average Crossovers are used occasionally to confirm a positive divergence. A positive divergence can be considered valid when a Bullish Moving Average Crossover occurs after the MACD Line makes its second "higher Low".

Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day.

What Does MACD Do?

MACD measures the difference between two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average (blue) and the slower moving average (red) is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.

This Merrill Lynch (MER) chart shows MACD as a solid black line, and its 9-day EMA as the thin blue line. Even though moving averages are lagging indicators, notice that MACD moves faster than the moving averages. In this example, MACD provided a few good trading signals as well:

1. In March and April, MACD turned down ahead of both moving averages, and formed a negative divergence ahead of the price peak.
2. In May and June, MACD began to strengthen and make higher Lows while both moving averages continued to make lower Lows.
3. Finally, MACD formed a positive divergence in October while both moving averages recorded new Lows.

Moving Average Convergence/Divergence (MACD)

Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend-following characteristics. These lagging indicators are turned into a momentum oscillator by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. MACD is a centered oscillator and the guidelines for using centered oscillators apply.

MACD Formula

The most popular formula for the "standard" MACD is the difference between a security's 26-day and 12-day Exponential Moving Averages (EMAs). This is the formula that is used in many popular technical analysis programs, including SharpCharts, and quoted in most technical analysis books on the subject. Appel and others have since tinkered with these original settings to come up with a MACD that is better suited for faster or slower securities. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator, less prone to whipsaws. For our purposes in this article, the traditional 12/26 MACD will be used for explanations. Later in the indicator series, we will address the use of different moving averages in calculating MACD.

Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. Usually, a 9-day EMA of MACD is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above its 9-day EMA, and a bearish crossover occurs when MACD moves below its 9-day EMA. The Merrill Lynch (MER) chart below shows the 12-day EMA (thin blue line) with the 26-day EMA (thin red line) overlaid the price plot. MACD appears in the box below as the thick black line and its 9-day EMA is the thin blue line. The histogram represents the difference between MACD and its 9-day EMA. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

MACD Patterns

I stopped counting the pips for the April 2006 testing as it completely
convinced me of the success of this method. I randomly tested it using previous years
and the results were amazing. Average of 300+ pips per month and then I only trade
the trades that gives signals at these times 17:00, 21:00 and 01:00 (GMT +2). It gives
between 8-10 deals per month using the mentioned timeframes.. (I use Metatrader and
data supply by MIG.)
If you use patterns in the MACD that occur regular that gives results and use
them every time they occur you will most definitely make money.
I haven’t discuss nor used trendlines so far in this document and when you add
them it will most definitely helps you in defining your exit levels. The entry level are
determine by the MACD but the exit or profit levels is determine by support and
resistance levels. I use the moving averages as described earlier as well as Fibonacci
levels and then most definitely trendlines and price levels. I normally take the daily
graph and draw the trendlines according to it and then go to the 4 hour graph. I make
them nice and thick so that I can see them. Then I draw the different price levels such
as 1.2900, 1.3000, 1.3100 etc. It is amazing to see how the price find support and or
resistance at these levels.
I hope that this document will help you on your way to financial independents

Price movement in MACD

Let us look at the graph. See how price levels play a roll in the support and
resistance of the price movement. Say we entered the trade at Entry above. Our first
profit target will be around our fast moving averages (8EMA and 21EMA). Our
second profit target will be around the slow moving averages(89SMA and365EMA).
Our third profit target will be at price level 1.2100 etc etc etc.
This is how you plan your trade in advance to take partial profits till you complete the
trade. Should there be a moving average or price level nearby and below your entry
level you must take note that the price might go and test them. So your stoploss must
be aware of that.
Again I ask you to study the movement of the price around the moving averages.
When the price are above the 89SMA the trend is normally up and visa versa. After
the price crosses the 89SMA it tends to pullback to the 21EMA before it carry on its
direction if it is a trend direction change otherwise it tend to test the 89SMA again and
then it runs over and across the 89SMA till it finds direction and then it pulls back to
the 21EMA before proceeding on its path.

support and resistance in MACD

Let us look at the graph above. See how price levels play a roll in the support and resistance of the price movement. Say we entered the trade at Entry above. Our firstprofit target will be around our fast moving averages (8EMA and 21EMA). Our
second profit target will be around the slow moving averages(89SMA and365EMA).
Our third profit target will be at price level 1.2100 etc etc etc.

This is how you plan your trade in advance to take partial profits till you complete the
trade. Should there be a moving average or price level nearby and below your entry
level you must take note that the price might go and test them. So your stoploss must
be aware of that.
Again I ask you to study the movement of the price around the moving averages.
When the price are above the 89SMA the trend is normally up and visa versa. After
the price crosses the 89SMA it tends to pullback to the 21EMA before it carry on its
direction if it is a trend direction change otherwise it tend to test the 89SMA again and
then it runs over and across the 89SMA till it finds direction and then it pulls back to
the 21EMA before proceeding on its path.

When MACD pulled back to the Zero line

This trade however was a bit risky as it was a breakout trade after ten days
consolidation testing a trendline angling upwards. One has to evaluate the risk not
only in terms of pips but also in terms of strategy and chart pattern. After a breakout
the price very often turns back to test the breakout level and then that level becomes
either support or resistance in this case it becomes Eur resistance.

Stoploss have to be inside the breakout otherwise it can be triggered and then
sometimes it can be very big before entry signal is given by the MACD.
Here is what I normally do when the MACD shows a signal but the stoploss are to big
in relation to my capital or what I am comfortable with. I enter the trade in three
stages with my stoploss set at the same level.

MACD and Moving averages

This was just to see and get a feeling for the graphs. Let us start to set-up our charts.
Moving Averages: First of all are the moving Averages that we are going to use.
1. 365 Exponential Moving Average (365EMA)
2. 200 Simple Moving Average (200SMA)
3. 89 Simple Moving Average (89SMA)
4. 21 Exponential Moving Average (21EMA)
5. 8 Exponential Moving Average (8EMA)

MACD:

MACD settings at

1. Fast EMA 5
2. Slow EMA 13
3. MACD EMA 1
Horizontal Lines: Three sets of horizontal lines above and below zero should be drawn on the MACD window at levels as well as one on zero
1. Level +0.0015
2. Level +0.0030
3. Level +0.0045
4. Level –0.0015
5. Level –0.0030
6. Level –0.0045

Your Graph should look like this: (Choose your own colour and styles)
The MACD moves in certain patterns that when recognized can be very profitable
trades. Let me show you the very important ones first. By not following every signal
but only the ones that gives high probability trades through certain MACD patterns
serves as a filter. The ones not familiar are not taken. This is the filter.

4 Hour MACD Forex Strategy

Welcome to the 4 Hour MACD Forex Strategy. This strategy is aimed at
simplicity as well as high probability trades. I have been in the equity market for
almost ten years now and in the forex market for two years. I learned very early that

forex trading is not for the shaky ones. One must have a tested and definite trading
strategy as well as well organized discipline to follow the strategy and execute the
plan as to the letter. One must be exact and precise.

Therefore I paper traded for almost two years and read everything I could lay
my hands on. I bought books and courses. I attend a 5 day live web seminar. All this
did not help me at all as it did not fit my style of personality and I just did not seem to
connect with all this different strategies. Over two years of watching the graphs with
different indicators, moving averages etc. I started to get a feeling for the movement and motion of the market especially the EurUsd around certain moving averages.
It wasn’t till late last year that I discover a setting with the MACD that gives
easy to read signals on a regular basis on a 4 hour timeframe. I like the 4 hour
timeframe as one are not glued to the screen full time.