We’ve all waited for the right time to buy/sell a stock when the MACD gives us the respective signal, however, most of the time the signal that we receive is either a false signal or the price action turns against our favour.
Before we start with the topic let us recap a bit and understand how and what MACD is.
Almost 1 out of 5 traders in the stock use the MACD signal to confirm their strategy and decide whether they want to go long or go short. Now let’s understand what MACD actually is.
MACD – Moving Average Convergence Divergence is a lagging indicator and is praised by investors for highest accuracy that it provides. It is often said that if you’re unhappy with the results of other indicators and you want to test out a new indicator so as to improve your ‘win’ percentage, then you should definitely consider giving MACD a chance.
Table of Contents
How to read?
The MACD graph contains a zero line. This is often regarded as the baseline or the ‘neutral line’ and a MACD (Blue line) wave hovers over this zero line (see the image attached). Notice that there’s another wave in orange. This wave is called as the ‘Signal wave’ or ‘Signal line’.
MACD is calculated from the following method:
26 EMA - 12EMA = MACD line
9 period EMA of MACD line = Signal line
It is to be noted that the signal line gives the buy and the sell signal to the investors.
When to Buy?
An investor should go long when there is a crossover of the Signal and the MACD line below the 0 line.
When to Sell?
An investor should plan to close their long position or take their short position when there is a crossover above the 0 line.
If you can see the graphs in the example above, the price action started to go up when there was a crossover of the Signal line and the MACD line below the 0 line.
If you would have taken up this trade then you would have easily booked 60 points in your favour.
How to improve accuracy and avoid false signals?
This is the most common problem that is faced by traders/investors when it comes to applying this signal in real-time. At Bytemine, our analysts realized that one way of increasing the accuracy and making sure the trade is successful is to only take the position:
When there is a crossover below or above the 0 line (as discussed above)
By taking the position after the second candle (with respect to the crossover) has closed.
Let’s understand this by an example:
In the image above, the crossover happened when there was a big green candle formed. Now to avoid false signals, always ensure that you do not buy during this time. Only take the buy position if the second candle’s close is above the previous candle’s high.
Although, in this case the price did not move as expected, however since our stoploss was placed at the previous candle’s low, we would have eventually booked a profit in this trade.
The same procedure applies to when you are shorting a stock. Only take the trade if the second (the latest) candles low is below the previous candle’s low – all this when the crossover of the Signal line and the MACD line is above the 0 line.
How to achieve 90% accuracy?
Achieving 90% accuracy is possible, yes. However, as a trader/investor you’d have to be careful in taking up the trade and making sure that the price action fulfills all of the setups discussed above.
Once you’re sure, then check the Support and Resistance levels of the stock in different time frames. Draw horizontal lines and mark the potential resistance and support zones. Switch back to the time frame that you prefer trading in and check where does the price action resides now.
If it is near a support level and there is a BUY signal being generated by MACD then you can surely take up that trade. On the other side, if there is a sell signal generated by MACD and if the price action is near a potential resistance level, then you can surely take your short position.
We hope you like this strategy and try to implement it the next time you take up a trade.
Do follow us on Twitter for more updates on Technical Analysis.