MACD Histogram

MACD Histogram was developed by Thomas Aspray in 1986 for reducing the time lag of the MACD crossover signals.

MACD generates buying or selling signals primarily as a lagging indicator even though it has some characteristics of leading indicators as well. This time lag may result in missing some important market moves. Because of the lagging characteristics, at times, we may get the signal quite late and hence may miss the opportunity to take the trading decision at the right time. The MACD Histogram helps in speeding up the signals by enabling us to anticipate the MACD crossover in advance.

Definition and Construction

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 the following illustration. This bar construction is called MACD Histogram. You will note that after a crossover, when the gap between the MACD line and it's signal line widen ups, we get longer bars. These start becoming shorter when the gap reduces. The green bars come into the picture when price starts rising and the red ones when the price drops.

Histogram illustration

MACD Histogram - Example 1

Histogram makes center line crossovers and divergences easily identifiable. If you look at the above chart, you would note that the Histogram makes a center line crossover, whenever the MACD crosses the trigger line. In the same chart the two yellow circles have been drawn as an example of the same. You may please note that at elsewhere  also the Histogram crossovers with the center line correspond to the MACD crossovers with the trigger line.

If the value of MACD is larger than the value of its 9-day EMA i.e. MACD line is above the trigger line, then the value on the MACD Histogram will be positive. Conversely, if the value of MACD is less than its 9-day EMA i.e. MACD is below the trigger line, 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 longer and vice-versa. Hence the longer bars indicate in the increase in the momentum and shorter bars reflect that the momentum of the ongoing trend is slowing down.

MACD Histogram was designed to anticipate a moving average crossover in the MACD. This is achieved by noting the Positive and Negative Divergences in the MACD-Histogram.

  • A Positive Divergence forms when the MACD Histogram forms a higher Low and the MACD continues going lower.
  • A Negative Divergence forms when the MACD Histogram forms a lower High and the MACD continues going higher.

Please see the following chart to understand about this positive and negative divergences.

Negative and Positive Divergences by MACD Histogram

MACD Histogram - Example 2

Explanation And Interpretation

Please refer the above chart. From point “X”, though the MACD continued going higher for some time but the Histogram started going lower. This was a case of negative divergence. This fact signaled that a bearish move could be expected. The actual MACD crossover took place at point “Y”. Point “Y” would signal us about the downward move 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 was a case of positive divergence. This positive divergence indicated the possibilities of a bullish move. The actual MACD crossover took place at point “Q”. Point “Q” signaled us for buying but Histogram had already indicated it at point “P”.

Divergence between MACD and the MACD Histogram is 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. On the other hand a negative divergence in the Histogram indicates that the MACD is weakening and market may start falling soon.

Notes:

The MACD Histogram is an indicator of an indicator because this was designed to predict the movement of another indicator i.e. MACD. This may make it to generate false signals more often 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 either use it as an early warning system with the MACD or use it longer time frame charts like daily chart. On short-term charts you may come across the false signals quite frequently. Another piece of advice would be to check the historical patterns on different common time frame charts to analyze the time frame with least number of false signals.

As true with all technical indicators, analyze the short time frame charts as well as a longer-time frame 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 those 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 their significance.

The following chart with MACD and MACD Histogram is for exercise. Please take note of each point of change with the reference of the above explanation. There is one point where MACD-Histogram signal was not effective even though it was not false. What it means is that at other points the Histogram gave early signals to buy or sell and those resulted in significant moves but at this particular point though the indicated move came but the movement thereafter was not significant.

Exercise

MACD Histogram - Example 3

As far as the question above is concerned, the answer is 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 significant moves and hence profits. But then, who says that the world is perfect MACD Histogram - 4.
 

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