What is the MACD Histogram and how to use it to enhance trading accuracy

The MACD Histogram is an important analytical tool in technical trading systems and a component that helps investors quickly and clearly identify trend changes. This indicator was developed in the late 1970s by Gerald Appel and remains popular among professional traders today.

Understanding MACD: The Main Components of the Indicator System

MACD stands for Moving Average Convergence Divergence, an indicator used to measure both price trend (Trend) and trend strength (Momentum). The system consists of three main parts:

1. The Main MACD Line

The MACD line is calculated by subtracting the 26-day EMA from the 12-day EMA. The resulting value indicates the trend direction:

• When MACD > 0: Short-term average is higher than long-term, indicating an uptrend.
• When MACD < 0: Short-term average is lower than long-term, indicating a downtrend.
• MACD Slope: An increasing slope shows growing momentum; a decreasing slope indicates weakening momentum.

2. Signal Line

The Signal Line is calculated as the 9-day EMA of the MACD line. It acts as a trigger line to confirm signals:

• MACD > 0 and Signal Line > MACD: Indicates a clear bullish trend.
• MACD < 0 and Signal Line < MACD: Indicates a confirmed bearish trend.

Traders can customize the Signal Line, such as using EMA(5) or EMA(7), for faster or slower signals depending on their needs.

3. MACD Histogram: Momentum Strength Indicator

The MACD Histogram is the difference between the MACD line and the Signal Line, displayed as a bar graph to visually assess trend strength. Calculated as: MACD Histogram = MACD – Signal Line

How to read the MACD Histogram:

• Histogram > 0 (positive): MACD is above the Signal Line, indicating an uptrend. Larger positive bars suggest increasing bullish momentum; decreasing bars suggest weakening bullish strength.

• Histogram < 0 (negative): MACD is below the Signal Line, indicating a downtrend. Larger negative bars suggest increasing bearish momentum; decreasing bars suggest weakening bearish strength.

• Histogram = 0 (critical point): MACD crosses the Signal Line, often signaling a trend reversal. This point is often used as a good entry signal.

Why Use EMA Instead of SMA

Moving Averages come in two types: SMA (Simple Moving Average), which assigns equal weight to all data points, and EMA (Exponential Moving Average), which gives more weight to recent prices. EMA responds faster to recent price changes, making MACD signals more timely and reliable.

Example Calculation of MACD Histogram from Real Data

The calculation steps are:

Step 1: Calculate EMA(12) = (P × k) + (EMA(12) previous × (1 - k))

Step 2: Calculate EMA(26) = (P × k) + (EMA(26) previous × (1 - k))

Step 3: MACD = EMA(12) – EMA(26)

Step 4: Signal Line = EMA(9) of MACD

Step 5: MACD Histogram = MACD – Signal Line

Using data from June 21 – July 21, 2023, for USDCHF, you can compute the EMA(12), EMA(26), MACD, Signal Line, and Histogram, which show the trend changes. For example, on June 21, MACD = 0 (a critical point), and on June 15, MACD = 0.0034, indicating a clear bullish signal.

What Does the MACD Histogram Indicate?

This tool offers multiple insights into price analysis:

1) Trend Direction

When the short-term EMA is above the long-term EMA, the MACD Histogram is positive, indicating an upward trend. Conversely, a negative MACD Histogram indicates a downward trend.

2) Momentum Strength

The size of the histogram bars reflects the strength of the trend. Larger bars mean stronger momentum; smaller bars suggest weakening momentum.

3) Momentum Volatility

When the MACD Histogram starts decreasing in positive value, it signals waning bullish momentum. When it decreases in negative value, bearish momentum is fading.

4) Divergence Detection

If prices reach new highs or lows but the MACD Histogram does not confirm with similar extremes, divergence occurs, warning of potential trend reversals.

How to Use MACD Histogram in Actual Trading

Method 1: Zero-Cross Strategy (Crossing the Center Line)

When MACD Histogram crosses zero, MACD crosses the center line, signaling a potential trend change:

• Buy Signal: MACD Histogram crosses from negative to positive, MACD crosses above the center line.
• Sell Signal: MACD Histogram crosses from positive to negative, MACD crosses below the center line.

Method 2: MACD Crossover (Crossing Signal Line)

A faster method:

• Buy Signal: MACD crosses above the Signal Line, even if Histogram is still negative, indicating a potential trend reversal.
• Sell Signal: MACD crosses below the Signal Line, even if Histogram is still positive.

Method 3: Momentum Change Monitoring

Observe the size of the histogram bars:

• Decreasing positive bars suggest weakening bullish momentum, possibly leading to a reversal.
• Decreasing negative bars suggest weakening bearish momentum.

Combining MACD Histogram with Other Indicators

MACD Histogram is most effective when used with other tools:

MACD Histogram + RSI

RSI measures overbought/oversold conditions, confirming trend direction:

• Strong Buy Signal: RSI enters oversold zone + MACD Histogram shifts from negative to positive.
• Strong Sell Signal: RSI enters overbought zone + MACD Histogram shifts from positive to negative.

MACD Histogram + Bollinger Bands

Bollinger Bands identify breakout points:

• Buy Signal: Price breaks below the lower band + MACD Histogram crosses above center line.
• Sell Signal: Price breaks above the upper band + MACD Histogram crosses below center line.

MACD Histogram + Price Patterns

When price forms patterns like triangles or double bottoms:

• Buy Signal: Price breaks structure + MACD Histogram turns positive.
• Sell Signal: Price breaks below structure + MACD Histogram turns negative.

Limitations of MACD Histogram

While powerful, MACD Histogram has limitations:

1. Lagging Indicator: It follows price movements, often signaling after the trend has begun, especially in volatile markets.

2. False Signals: In highly volatile markets, it may generate multiple false signals, with zero-crosses and crossovers occurring frequently.

3. Less Effective in Sideways Markets: In ranging markets, MACD Histogram may produce whipsaws with little predictive value.

Therefore, it’s best to use MACD Histogram alongside other tools like trendlines, support/resistance levels, or price patterns to improve accuracy.

How to Set Up MACD Histogram on Trading Platforms

On Mitrade:

1. Add Indicator: Click “Add Indicators” and select MACD.
2. Configure Settings: Click Settings to adjust:
   • Fast Length (EMA short): default 12
   • Slow Length (EMA long): default 26
   • Signal Length: default 9
3. Apply: Save settings and the MACD Histogram appears on your chart.

Traders can practice with a demo account with $50,000 virtual funds on Mitrade to master MACD Histogram usage.

Summary

The MACD Histogram is a powerful analytical tool that helps traders identify trend changes and measure market momentum clearly. It indicates the difference between the MACD line and the Signal Line, making it easy to analyze trend shifts quickly. However, successful trading relies on combining MACD Histogram with other tools and a deep understanding of market behavior. Regular practice with demo accounts and real trading experience are key to developing a profitable trading system.