So before assuming that divergence is a reliable tool to use in your trading, let’s dig deeper into what MACD divergence is, what causes it and how to improve the use of divergence. Learn everything you need to know about trading the markets from beginner level to the most advanced, helping you to create critical skills and techniques to you can apply in your trading right away. Trade up today – join thousands of traders who choose a mobile-first broker.
A bullish crossover occurs when the MACD turns up and crosses above the signal line. A bearish crossover occurs when the MACD turns down and crosses below the signal line. Crossovers can last a few days or a few weeks, depending on the strength of the move. The MACD line is the 12-day Exponential Moving Average (EMA) less the 26-day EMA. A 9-day EMA of the MACD line is plotted with the indicator to act as a signal line and identify turns.
Common Problems With MACD Divergence
If MACD is above the signal line, the histogram will be above the MACD’s baseline, or zero line. If MACD is below its signal line, the histogram will be below the MACD’s baseline. Traders use the MACD’s histogram to identify when bullish or bearish momentum is high—and possibly overbought/oversold.
- Centerline crossovers can last a few days or a few months, depending on the strength of the trend.
- In short, a regular divergence provides a trend reversal signal, while a hidden divergence provides a trend continuation signal.
- As its name implies, the MACD is all about the convergence and divergence of the two moving averages.
- Bearish divergences are commonplace in a strong uptrend, while bullish divergences occur often in a strong downtrend.
- Traders are better off focusing on the price action, instead of divergence.
- This setup is frequently seen in situations where the price has been in consolidation or has performed a pullback from an uptrend.
Divergence trading strategy requires you to pay attention not just to the indicator, but also to price itself. The MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to identify levels that are historically overbought or oversold, the MACD does not have any upper or lower limits to bind its movement.
Always Utilize Price Action With Divergence
The higher high in the security is normal for an uptrend, but the lower high in the MACD shows less upside momentum. Even though upside momentum may be less, upside momentum is still outpacing downside momentum as long as the MACD is positive. Waning upward momentum can sometimes foreshadow a trend reversal or sizable decline. Centerline crossovers can last a few days or a few months, depending on the strength of the trend. The MACD will remain positive as long as there is a sustained uptrend. The next chart shows Pulte Homes (PHM) with at least four centerline crosses in nine months.
This setup is frequently seen in situations where the price has been in consolidation or has performed a pullback from an uptrend. This setup, therefore, indicates that price still has some upside momentum and that any pullback is more likely the outcome of profit taking from previous buyers as opposed to strong selling. The emergence of a hidden bullish divergence represents a signal that the prior uptrend is likely to continue. The next chart shows Google (GOOG) with a bullish divergence in October-November 2008. First, notice that we are using closing prices to identify the divergence. The MACD’s moving averages are based on closing prices and we should consider closing prices in the security as well.
Trading Rules – MACD Hidden Divergence
Just like the overt divergence setups, hidden divergence setups can be of the bullish or bearish variety. Furthermore, the bullish divergence RSI signal uses a special setup on the RSI signal line known as the failure swing. The bullish divergence setups using the RSI and the MACD indicators are shown below. This article will present a clear-cut way of identifying bullish and bearish divergence setups on the charts.
- Moving average convergence/divergence (MACD, or MAC-D) is a trend-following momentum indicator that shows the relationship between two exponential moving averages (EMAs) of a security’s price.
- Below is a chart of Cummins Inc (CMI) with seven centerline crossovers in five months.
- The chart below shows a stock gapping higher and then accelerating to the upside.
- These two indicators are often used together to give analysts a more complete technical picture of a market.
- Waning upward momentum can sometimes foreshadow a trend reversal or sizable decline.
If monitoring divergence, an entire day of profits on the downside would have been missed. Harness past market data to forecast price direction and anticipate market moves. From beginners to experts, all traders need to know a wide range of technical terms. Crossovers are more reliable when they conform to the prevailing trend.
MACD Divergence Cheat Sheet [Free Download]
In hindsight, divergence looks great; many examples can be found where a reversal was preceded by MACD divergence. This is a daily chart of the S&P exchange-traded fund, SPY, with the MACD histogram on the lower panel. Just be aware of the pitfalls, and don’t use the indicator in isolation.
MACD is calculated by subtracting the long-term EMA (26 periods) from the short-term EMA (12 periods). An EMA is a type of moving average (MA) that places a greater weight and significance on the most recent data points. Price is the ultimate indicator, with momentum indicators simply manipulating price data. The price continues to trend higher, but the MACD on several occasions does not make new highs and instead creates lower highs. Oscillators like RSI, stochastics, and MACD are powerful tools if you know how to use them. Looking out for divergences is a part of using oscillators for trading.
Various platforms provide different variations of the MACD indicator. The MACD indicator used above is obtained from the ThinkMarkets MT4 platform. For those interested in MACD and divergences in general, here are some resources for further study. To start, we suggest you download our MACD cheat sheet and use it at the beginning of your trading career.