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MACD is one of many trend following indicators that attempts to identify trend changes. Three different types of trading signals can be generated:
- MACD line crossing the signal line.
- MACD line crossing 0.
- Divergence between price and histogram, or between MACD line and price.
The signal line crossing is the most basic application of MACD. Standard interpretation is to buy when the MACD crosses up through the signal line and sell when it crosses down through the signal line.
The histogram is used to easily show when a crossing has occurred. When the MACD line crosses through zero on the histogram it is said that the MACD line has crossed the signal line. The histogram can be beneficial in visualizing when the two lines are coming together. Both may still be rising, but coming together, so a falling histogram suggests a crossover may be approaching.
A crossing of the MACD line up through zero is interpreted as bullish, or down through zero as bearish. These crossings are simply the EMA(12) line crossing up or down through the slower EMA(26) line.
Divergence between MACD and price happens when price makes a new selloff low, but the MACD doesn't make a new low, it remains above where it fell to on that previous price low. This is interpreted as bullish positive divergence, and suggests the downtrend may be almost over. Negative divergence is the same thing when rising, that is, price makes a new rally high but MACD doesn't rise as high as before, this is bearish.
Divergence may be interpreted on the price versus the histogram, where the new price levels are not confirmed by new histogram levels. Longer and sharper divergences are regarded as more significant than small shallow patterns in this case.
It helps to look at the MACD on a weekly scale before looking at a daily scale as to avoid making short term trades against the direction of the intermediate trend.
Often you will see the stochastic oscillator getting overbought or oversold just as the MACD is crossing, so it is sometimes helpful to wait for a small correction of the overbought / oversold conditions before initiating a trade based on the MACD crossover.