Normal MACD gives us buying or selling signals primarily as a lagging indicator even though it has some characteristics of leading indicators as well. Because of this time lag sometimes important market moves are missed i.e. we may get the signal quite late and may miss the opportunity to take the trading decision at the right time. MACD Histograms helps in speeding up the signals by enabling us to anticipate the MACD crossover in advance.
MACD Histogram was developed by Thomas Aspray in 1986 for reducing the time lag of the MACD crossover signals as mentioned above.
The MACD Histogram represents the difference between the MACD and its signal line. For ready reference in our example, the signal line or trigger line is the 9-day EMA of main MACD.
This difference between the MACD and its signal line is presented as bars. Please refer example 5. This bar construction is called MACD Histogram.
Histogram makes center line crossovers and divergences easily identifiable. If you see the example 5 above, you would note that the Histogram makes a center line crossover whenever the MACD crosses the trigger line. In example 5 the two yellow circles have been drawn as one example. You may please note that at other places also the Histogram crossing over the center line corresponds to the MACD crossing over the trigger line.
If the value of MACD is larger than the value of its 9-day EMA, then the value on the MACD Histogram will be positive. Conversely, if the value of MACD is less than its 9-day EMA, then the value on the MACD Histogram will be negative.
Further increases or decreases in the gap between MACD and its trigger line is reflected in the MACD Histogram. Whenever the gap increases, the histogram bars becomes bigger and vice-versa. Hence bigger bars tell us that the momentum is increasing.
MACD Histogram was designed to anticipate a moving average crossover in the MACD. This is achieved by looking at the Positive and Negative Divergences in the MACD-Histogram.
Please see Example 2 to understand about this positive and negative divergences.
Please refer the chart in Example 2 above. From point “X”, though the MACD continued going higher for some more time but the Histogram started going lower. This is negative divergence. This signals that after the uptrend, a bearish move may come. The actual MACD crossover took place at point “Y”. Point “Y” would signal us about the downtrend and hence to “Sell” but Histogram indicated it earlier at point “X”.
Similarly, from point “P” though the MACD continued to go lower but the Histogram started going up. This is positive divergence. This signals that a bullish move may come now and market may start going up. The actual MACD crossover took place at point “Q”. Point “Q” would signal us for buying but Histogram indicated it earlier at point “P”.
Divergences between MACD and the MACD Histogram are the main tool used to anticipate moving average crossovers. A Positive Divergence in the MACD Histogram indicates that the MACD is strengthening and could be on the verge of a Bullish Moving Average Crossover. A Negative Divergence in the MACD Histogram indicates that the MACD is weakening and market may start falling soon.
The MACD Histogram is an indicator of an indicator because this was designed to indicate the movement of another indicator i.e. MACD. This may make it to give false signals more frequently as it is not “directly connected to the “price action”. MACD is connected to the “price action” and Histogram is connected with MACD. Because of this fact please avoid using MACD Histogram in isolation and use it with the combination of other indicators to be able to filter out some of the false signals.
As true with all the technical indicators, have two pictures with MACD. The broader picture e.g. weekly or daily chart and then the short term charts e.g. hourly charts. If the signal from longer-term chart and shorter-term charts are in synch (agree to each other) then the MACD signals would have better probability of going true.
Please be careful of small and shallow divergences as they may create false signals. One method to avoid small divergences is to look for larger divergences with two or more readily identifiable peaks or troughs. Compare the peaks and troughs from past action to determine its significance
Example 7 below is for exercise. In this chart MACD, MACD Histogram and price actions are there. Please take note of each point of change in reference to the explanation above. There is one point where MACD-Histogram signal was not effective even though it was correct. The meaning is that at other points the Histogram gave early signals to buy or sell and it could increase profit but at one point even though Histogram gave an early signal, the profit with that signal was less.
Well the chart 7 above is more for taking note of each point to have a better understanding of different movements (without explanations). As far as the question above is concerned, its point “A” (MACD Histogram signal) and point “B” (MACD crossover signal). The Histogram signal was early for buying but it proved to be too early as the market kept on going down instead of going up. At other points the Histogram signals were early and also resulted in higher profits…. But then, who says that the world is perfect