MACD Histogram Trading Strategy in 2024 Rules, Setup, Backtest, Example

Disregard signals close to the zero line unless confirmed by a
divergence. The values of 12, 26, and 9 are the typical settings used with the MACD, though other values can be substituted depending on your trading style and goals. Usually, it can be segregated into two parts, i.e. bullish peak and trough divergence and bearish peak and trough divergence. On the other hand, if someone considers a longer time frame then the slow Signal line reflects market consensus. MACD histogram depicts the difference between long-term and short-term consensus.

1. Building upon the concept of a triple exponential moving average and momentum, we introduce to you the TRIX indicator.
2. Chart 1 shows Darden Restaurants (DRI) with MACD and the MACD-Histogram.
3. This proves that a very simple strategy can be very efficient.
4. The RSI is an oscillator that calculates average price gains and losses over a given period of time.
5. If a trader entered a long position when the MACD crossed from below, they would be left with a losing stock if prices continued to fall.

Orders placed by other means will have additional transaction costs. Divergence refers to a situation where factors move away from or are independent of others. Regarding MACD, it is a situation where price action and momentum are not acting together. For instance, divergence can indicate a period where the price makes successively lower highs, but the macd histogram shows a succession of higher lows.

Calculating MACD

Some of the concepts mentioned in this article are the results of my speculation based on the theories of Dr. Alexander Elder and John J. Murphy. The best way to combine them is to use weekly signals to determine market direction and the daily signals to fine-tune entry and exit points. But before proceeding further I would request you to recapitulate MACD (moving average convergence divergence). It will help me to explain this article without taking the additional burden.

What are the limitations of the MACD?

That’s right, you should ignore sell signals when the MACD stock indicator is above zero. Conversely, if the MACD stock indicator is above the zero line, do not open any short positions. I mainly use the MACD on day trades, but you mentioning the momentum changes with the Histogram, was something I was not aware of. It is the difference between the current stock price and the lowest low in the last 14 days, divided by the difference between the highest high and the lowest low. When the value is above 80, it indicates that the stock is overbought, and when it is below 20, it means the stock is oversold.

What is a MACD bullish/bearish divergence?

As trading proceeds, you observe the MACD initially crossed the zero line from below, then crossed again from above. A trader might notice the histogram bars moving down with the MACD, indicating a possible reversal and opportunity for a short trade. The moving average convergence divergence was invented by Gerald Appel. It is always better to use a  mix of technical indicators, instead of a single indicator for making better trading decisions. To analyze your trade, you should go for the best trading app that can give you proper analytics for tracking.

To fully harness this momentum and trend indicator to its maximum capability, it’s essential to understand where it triumphs and where it can fall short. Firstly, divergence can often signal a false positive, i.e., a possible reversal, but no actual reversal occurs. This is because prices often demonstrate a few surges or plunges as market participants set off stops to match the supply and demand in the order flow. Secondly, divergence doesn’t forecast all reversals, i.e., it predicts too many reversals that don’t occur and not enough real price reversals. The two lines within the indicator may look like simple moving averages (SMAs), but they are in fact layered exponential moving averages (EMAs).

When is the best time to use MACD?

Traders who use the MACD indicator often are critical of the fact that it may signal an entry after the initial move has begun and therefore leave pips behind. As such, many traders wanting to enter a trade sooner dismiss it as a “lagging” indicator. Another potential buy and sell signal is shown in the graph above in the Nasdaq 100 exchange-traded fund QQQQ chart. When MACD forms a series of two falling highs that correspond with two rising highs on the price, a bearish divergence has been formed. A bearish divergence that appears during a long-term bearish trend is considered confirmation that the trend is likely to continue.

When using the zero cross strategy, it is crucial to understand where to exit the market, or place a stop. The market in the below example provides several trendline breaks, which would have signalled a good time to exit the trade. Alternatively, a trader could use a break below the previous swing low (uptrend) or above the prior swing high (downtrend) to exit the trade. This is often seen as the slowest signal of the three, so you will typically see fewer signals, but also fewer false reversals.

Using Multiple Technical Analysis Tools

From these three positions, we would have gained a profit of $3.86 per share. Feel free to stress test each of these strategies to see which one works best with your trading style. For each of these entries, we recommend you use a stop limit order to ensure you get the best pricing on the execution. Divergence may not lead to an immediate reversal, but if this pattern continues to repeat itself, a change is likely around the corner.

A bearish signal line crossover occurred in late September, turning the MACD-Histogram negative. A bullish signal line crossover occurred in early December, turning the MACD-Histogram positive for the rest of the month. There was a period of divergence as MACD moved further from its signal line (green line) and a period of convergence as MACD moved closer to its signal line (red line). The MACD line is calculated by subtracting a long-term exponential moving average (EMA) from a shorter-term exponential moving average. Generally, these are the twelve-day and 26-day EMA, calculated based on each day’s closing price.

Lawrence has served as an expert witness in a number of high profile trials in US Federal and international courts. Nevertheless, the MACD technical indicator made a clear lower low from Low #1 to Low #2. This bearish divergence warned of the impending downturn of the S&P 500 future and the market as a whole. This occurs because there is a change in direction or a slowdown in the stock, future, bond, or currency trend. Similarly, when the MACD crosses below the MACD Signal Line a possible sell signal is generated.

However, MACD fundamentally supports traders in determining when the recent momentum in a security price may indicate a change in its underlying trend. This helps traders to make appropriate decisions with their entry and exit of trades. https://g-markets.net/ MACD value is positive when the 12-day EMA (blue line) is above the 26-day EMA. It is important to know that when the stock price is rising, the short-term average will usually be greater than the long-term moving average.

This method should be used carefully, as the delayed nature means that fast, choppy markets would often see the signals issued too late. However, as a tool for providing reversal signals of long sweeping moves, this can be very useful. For comparing momentum readings across different securities, the Percentage Price Oscillator (PPO) should be used instead of the MACD. By averaging up their short, the trader eventually earns a handsome profit, as the price makes a sustained reversal after the final point of divergence. Any contraction in the histogram is not only a signal of weakness in momentum but also the first step towards a signal line crossover. By now you must have understood how the histogram dances to the tunes of prices.