All MACD lines and their crossing
On a typical chart the MACD shows two lines (the MACD line and the Signal line), as well as the zero line. They cross each other often enough to give us plenty of options for building various MACD crossover trend following strategies. Some of them are the classics of quantitative trading.
What MACD really means
MACD is calculated using two exponential moving averages and its value equals the value of the shorter period (faster) EMA less the value of the longer period (slower) EMA. See the basics of MACD.
Therefore, the MACD line itself always represents the distance between the two moving averages. When MACD line crosses the zero line, it is exactly at the same time when the faster EMA crosses the slower EMA.
1. The very basic: trading on MACD line crossing the zero line
The simplest strategy you can think of with MACD is trading when the MACD line crosses the zero line. When the MACD line crosses above zero, you buy. When it crosses below zero, you sell.
Because MACD is in fact a distance between two moving averages, this trading strategy is exactly the same as trading crossovers of two moving averages. There is zero difference. While it is not impossible to make such a simple trend following strategy work even in these days, it is quite unlikely that you will have great success with trading EMA crossovers (or MACD zero line crossovers) on a standalone basis. The many losing trades in non-trending markets will get you.
2. Signal line crossing the zero line
An alternative is using the Signal line instead of the MACD line and enter trades when it crosses the zero line. Now what exactly is the MACD Signal line? It is a smoothed (lagged) version of the MACD line, as it is calculated as an EMA of the MACD.
Besides being more lagged, this approach is not much different from the previous one. Smoothing the MACD line using the Signal line eliminates some losing crossovers, but creates a few others from the previously winning ones. Furthermore, it gets you into good trends even later. Conclusions are the same as with basic MACD zero line crossovers: very hard to make it work without additional improvements.
3. MACD zero line crossovers with waiting for confirmation
Alternatively you can improve the MACD zero line crossover strategy by waiting for the first correction after the MACD has crossed the zero line. While sometimes this correction will enable you to get a better entry price and smaller risk, in some other cases the first correction never comes and you won’t get into the position – unfortunately these are usually the cases when the pure MACD zero line crossover would have been profitable. Sometimes the first correction will evolve into a trend reversal and you will lose.
However, waiting for the first correction can work and can improve your strategy. Many people use this idea and not only with MACD. It is quite common with moving averages, when traders wait until price touches the moving average and then enter a trade in the direction of the trend. It only needs some testing and fine tuning.
4. MACD line crossing the Signal line
Finally after going through some really simple approaches we are getting to probably the most popular and classic way to trade the MACD – the crossover of the two lines.
You enter a long position when the MACD line crosses above the Signal line. This situation signals that the bearish momentum is probably over and there is a good chance of price moving up. On the contrary, when the MACD line crosses below the Signal line, it is a sell signal.
Of course, being classic and popular doesn’t make this approach a universal winner. The advantage over the simple MACD crossovers mentioned above is that it doesn’t wait for the MACD to cross the zero line and therefore there is less lag behind the price – sometimes the delay is so small that you can even question this trading approach being trend following. You usually act on just a little slowdown of the momentum in the original trend, which makes the two lines cross. Sometimes this makes you catch a great new trend in the very beginning, while sometimes market resumes the original trend and you are stopped out (yes, using stop-losses is highly recommended with all MACD strategies).
Trend following with MACD: summary
Think of MACD crossovers as trend following strategies – with all their strengths and weaknesses.
Don’t expect the most simple and obvious methods to bring you great results on a standalone basis (possible – yes; probable – not that much). Markets are competitive.
Try to improve or filter the simple MACD crossover system with another strong idea. You can wait to enter on the first correction after you have identified a new trend using MACD. Or you may find ways to define non-trending market and avoid taking MACD signals under these circumstances.