What Is the MACD Histogram and How Is It Used?

Technical analysis is a method used to predict future price movements of financial assets by studying historical market data, primarily price charts and trading volume. Technical indicators assist traders in identifying patterns and signals within this data, helping to understand market sentiment and potential shifts in asset prices.

Foundational MACD Concepts

The Moving Average Convergence Divergence (MACD) is a momentum indicator that reveals the relationship between two moving averages of an asset’s price. It is a widely used tool in technical analysis.

The MACD line is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA of a security’s closing prices. This line oscillates around a zero line, indicating short-term momentum relative to longer-term momentum. A positive MACD line suggests the shorter EMA is above the longer EMA, pointing to upward momentum, while a negative value indicates downward momentum.

The Signal line is a 9-period EMA of the MACD line. This line acts as a trigger for potential buy or sell signals. When the MACD line crosses above the Signal line, it is considered a bullish signal, while a cross below suggests a bearish signal.

Defining the MACD Histogram

The MACD Histogram provides a visual representation of the relationship between the MACD line and its Signal line. It quantifies the distance between these two lines, offering a clearer picture of momentum changes. This histogram is displayed as bars above and below a zero line.

To calculate the MACD Histogram, subtract the Signal line from the MACD line. When the MACD line is above the Signal line, the histogram bars are positive and appear above the zero line. Conversely, when the MACD line falls below the Signal line, the histogram bars are negative and extend below the zero line. This illustrates the convergence and divergence of the MACD and Signal lines, reflecting the strength and direction of market momentum.

Interpreting Histogram Readings

Interpreting the MACD Histogram involves observing the position, height, and direction of its bars relative to the zero line. Positive bars, appearing above the zero line, signify the MACD line is above its Signal line, indicating bullish momentum. Conversely, negative bars, extending below the zero line, mean the MACD line is below the Signal line, suggesting bearish momentum.

The height of the histogram bars provides insight into the momentum’s strength. Taller bars, whether positive or negative, signify increasing momentum, indicating that the MACD line and Signal line are diverging further from each other. Conversely, shrinking or shorter bars suggest that momentum is weakening, as the two lines are converging. This pattern can signal a potential shift or slowdown in the prevailing trend.

Divergence between an asset’s price action and the MACD Histogram can signal potential trend reversals. A bullish divergence occurs when an asset’s price makes lower lows, but the MACD Histogram forms higher lows, suggesting underlying bearish momentum is weakening. Conversely, a bearish divergence happens when the price makes higher highs, but the histogram makes lower highs, indicating bullish momentum may be fading.

Zero-line crossovers of the MACD Histogram correspond to crossovers between the MACD line and the Signal line. When the histogram crosses from negative to positive, it indicates a bullish crossover of the MACD and Signal lines. When it crosses from positive to negative, it signals a bearish crossover. These crossovers identify broader trend shifts, with a cross above zero suggesting a potential bullish trend and a cross below implying bearish momentum.

Applying the Histogram in Trading

Traders utilize the MACD Histogram to anticipate potential shifts in price direction. One primary application involves identifying potential trend changes or accelerations. For instance, increasing positive bars can confirm strengthening upward momentum, while decreasing positive bars might signal a weakening uptrend before a price reversal becomes evident on the chart.

The histogram also confirms existing trends. If an asset is in an uptrend, consistently positive histogram bars reinforce the strength of that upward movement. Similarly, strong negative bars can confirm a downtrend. This confirmation helps traders assess the durability of a trend.

Histogram signals, such as divergences or changes in bar height, are used with other technical analysis tools. For example, a bullish divergence on the histogram might be considered a stronger signal if it occurs near a support level or is confirmed by other indicators. This multi-indicator approach helps filter out false signals and improve decision-making.

The MACD Histogram acts as a leading indicator of momentum, providing early warnings of potential turning points before they are visible in MACD line crossovers or on the price chart. It helps traders gauge the pace at which momentum is changing, allowing them to anticipate shifts in market sentiment and time their entries and exits.