Binary Options Trading Strategies: how to trade with the MACD
Definition and calculation of the MACD (Moving Average Convergence Divergence)
The MACD is the difference between the 12-day exponential moving average (EMA) and the 26-day EMA. Against the MACD is usually drawn also its 9-period exponential, called signal line, which acts as a kind of trigger for entry buy and sell signals. Finally, we have the MACD Histogram which represents the difference between the MACD and its 9-day EMA: positive when the MACD is above the signal line and negative when the MACD Line is below the signal line.
MACD: (12-day EMA - 26-day EMA)
Signal Line: 9-day EMA of MACD Line
MACD Histogram: MACD - Signal Line
The most common parameters (12, 26 and 9) may be changed according to the behaviour of the security price and to the trading strategies of the trader.
The shorter moving average (12-day) is faster, whilst the longer moving average (26-day) is slower and less reactive to price changes in the underlying security.
A positive MACD indicates that the 12-day EMA is above the 26-day EMA; upside momentum increases when the 12-period EMA diverges further from the 26-period EMA.
A negative MACD indicates that the 12-day EMA is below the 26-day EMA; downside momentum increases when the 12-period EMA diverges further below the 26-period EMA.
All this makes it clear that the MACD is at the same time a trend-following and momentum indicator.
In the example above, the yellow area shows the MACD Line in negative territory and the orange area highlights a period of positive MACD values.
MACD does not have any upper or lower limits, which makes it not particularly good for identifying overbought and oversold levels; even though it is always possible to identify levels that are historically overbought or oversold, the MACD can continue to over-extend beyond its historical extremes.
MACD is calculated using two moving averages and its values depend on the price of the underlying asset: for a $20 stocks MACD may range between -1.5 and 1.5, whilst for a $100 stock MACD may vary between-10 to +10. For this reason it is not possible to compare MACD values between two or more securities with different prices.
How to use the MACD indicator
1. Crossovers between MACD and signal line
The MACD rises above the signal line: bullish signal.
The MACD falls below the signal line: bearish signal.
Signal line crossovers are the most common MACD signals. As moving average of the indicator, the signal line trails the MACD and makes it easier to spot MACD turns. A bullish crossover occurs when the MACD crosses above the signal line, whilst a bearish crossover occurs when the MACD crosses below the signal line.
The chart below shows IBM with its 12-period EMA (green), 26-period EMA (red) and the 12,26,9 MACD in the indicator window. There were eight signal line crossovers in six months: four up and four down, some good signals and some bad signals. Even after the two bearish signal line crossovers in April and May, IBM continued to move higher: upward momentum slowed down but it remained stronger than downside momentum.
2. Crossovers between MACD and zero line
Centerline crossovers are the next most common MACD signals.
- When the MACD is below the zero line (the short-term average is below the long-term average), the momentum is downward and this represents a bearish signal.
- When the MACD is above the zero line (the short-term average is above the long-term average), the momentum is upward and this represents a bullish signal.
3. Divergences between MACD and price
Divergence occurs when the security price movement diverges from the MACD movement, meaning that there is a high probability about the end of the current trend.
When the price hits a new high but the MACD indicator makes a lower high, we have a slow down of the upward momentum, and there is a high probability of a correction or even of the begin of a new downtrend; when the new low of the price is not confirmed by a new low of the MACD, the downside momentum is getting weaker and there is a high probability of a correction or even of the begin of a new uptrend.
The next chart shows Google (GOOG) with a bullish divergence in October-November 2008. There were different steps confirming the trend reversal:
- the MACD formed a higher low and Google formed a lower low in November,
- the MACD turned up with a bullish divergence with a signal line crossover in early December,
- Google confirmed a reversal with resistance breakout.
Divergences alone are not enough to mark an entry point. Bearish divergences are quite common in strong uptrends: even though the uptrend continues, it continues at a slower pace that causes the MACD to decline from its highs; in other words upside momentum may not be as strong, but still stronger than downside momentum. The opposite in a strong downtrend: bullish divergences do occur quite often, but the price keeps moving south as downward momentum is still stronger than upward momentum.
The next chart shows the S&P 500 ETF (SPY) with four bearish divergences from August to November 2009; nevertheless the ETF kept moving higher as the upside momentum was still stronger than downside momentum, even if at a lower pace, as long as its MACD is positive.
Below is another example of a bearish divergence from August to October in Gamestop (GME). The stock made a higher high at 28 and MACD made a lower high and the MACD/signal line crossover followed by the breakout of the support at 25.5 created a bearish signal.
MACD and Speedlines
The MACD indicator is a the same time a momentum and trend-following indicator and it can be applied to different timeframe, from the 5-minute to the daily, weekly or monthly charts. If you like to have a more sensible indicator, you may switch to a shorter short-term moving average and a longer long-term moving average, for example to a MACD (5,35,5); if you want less sensitivity you might consider lengthening the moving averages, and getting a less sensitive MACD which will still oscillate above/below zero, but with less frequent centerline and signal line crossovers.
Choose Speedlines trading system to pick the best entry points
Even if the MACD is a better tool to determine the entry point than the Bollinger Bands and the RSI, you need a trading system that tells you exactly when to enter: Buy Speedlines, The Binary Optioner's flagship trading system.