Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of prices. As a lower indicator, MACD appears in a separate panel below the price chart, using three components – the MACD line, signal line, and histogram – to reveal changes in strength, direction, and momentum of a trend. For option traders, MACD excels at identifying when trends are gaining or losing steam, helping time entries for selling premium when momentum shifts are likely. Unlike simple overbought/oversold indicators, MACD captures both trend and momentum, making it invaluable for avoiding trades against strong directional moves.
How MACD Works
MACD uses three calculated components:
The Three Elements
- MACD Line: 12-period EMA minus 26-period EMA
- Signal Line: 9-period EMA of the MACD line
- Histogram: MACD line minus Signal line
These work together to show momentum changes.
Standard Settings (12, 26, 9)
- 12 EMA: Fast moving average (responsive)
- 26 EMA: Slow moving average (smooth)
- 9 Signal: Trigger line for trades
Can be adjusted but defaults work well for most timeframes.
Reading MACD Signals
As a lower indicator, MACD provides clear visual signals:
Centerline Crosses
MACD above zero: 12 EMA > 26 EMA (bullish)
MACD below zero: 12 EMA < 26 EMA (bearish)
Signal Line Crosses
MACD crosses above signal: Bullish momentum shift
- New uptrend potentially starting
- Put selling opportunities developing
- Wait for confirmation
MACD crosses below signal: Bearish momentum shift
- New downtrend potentially starting
- Call selling opportunities developing
- Momentum weakening
MACD Histogram
The histogram visualizes momentum strength:
Reading the Histogram
- Growing positive bars: Bullish momentum accelerating
- Shrinking positive bars: Bullish momentum waning
- Growing negative bars: Bearish momentum accelerating
- Shrinking negative bars: Bearish momentum waning
The histogram often turns before price, providing early warnings.
Histogram Trading Signals
Peak and Trough Formation:
- Histogram peaks = momentum exhaustion up
- Consider selling calls
- Histogram troughs = momentum exhaustion down
- Consider selling puts
Watch for histogram divergences with price.
MACD Divergences
The most powerful MACD signals:
Bullish Divergence
Price makes lower low, MACD makes higher low:
- Downward momentum weakening
- Reversal likely upward
- Prime put selling setup
- Often occurs at major bottoms
Bearish Divergence
Price makes higher high, MACD makes lower high:
- Upward momentum weakening
- Reversal likely downward
- Prime call selling setup
- Often occurs at major tops
Multiple divergences increase reliability.
MACD for Option Strategies
Applying this lower indicator to options:
Weekly Option Timing
Put Selling Setup:
- MACD histogram bottoming (momentum exhaustion)
- MACD line hooking up from below signal
- Price near support level
- Sell OTM puts for reversal
Call Selling Setup:
- MACD histogram topping (momentum exhaustion)
- MACD line rolling over from above signal
- Price near resistance level
- Sell OTM calls for reversal
Trend Confirmation
Strong uptrend characteristics:
- MACD stays above zero
- Pullbacks find support at signal line
- Histogram stays mostly positive
- Only sell puts on pullbacks
MACD Settings for Different Timeframes
Adjust this lower indicator for your options:
Timeframe Matching
- 5-minute chart: Day trading (3, 10, 16)
- Hourly chart: Weekly options (12, 26, 9)
- Daily chart: Monthly options (12, 26, 9)
- Weekly chart: LEAPS (6, 13, 5)
Faster settings = more signals but more noise.
Custom Settings
Fast MACD (6, 13, 5):
- More responsive
- Weekly option traders
- More false signals
- Requires confirmation
Slow MACD (24, 52, 18):
- Major trend changes only
- Position traders
- Fewer but stronger signals
- Less management needed
Combining MACD with Price Action
This lower indicator works best with context:
MACD + Support/Resistance
- MACD bullish cross at support
- Double confirmation for puts
- Higher probability reversal
- Clear stop levels
MACD + Moving Averages
MACD + RSI
- MACD momentum shift + RSI oversold
- Reversal highly probable
- Size up put sales
- Multiple confirmations
Common MACD Mistakes
Selling Against Strong MACD: Fighting momentum Ignoring Histogram: Missing early warnings Too Fast Settings: Whipsawed constantly No Price Context: MACD in isolation fails
Advanced MACD Strategies
Sophisticated uses of this lower indicator:
MACD Squeeze Pattern
When MACD and signal converge tightly:
- Volatility contraction
- Big move coming
- Prepare for breakout
- Buy options or wait
Hidden Divergences
Trend continuation signals:
- Price higher low, MACD lower low (bullish)
- Price lower high, MACD higher high (bearish)
- Trade with trend after pullback
- High probability setups
Building a MACD System
Systematic approach using this lower indicator:
MACD Option Selling Rules
- Only trade with MACD trend (above/below zero)
- Enter on signal line crosses in trend direction
- Exit if divergence appears against position
- Size down when histogram shrinking (momentum waning)
- Confirm with price action always
Weekly Income Example
- Scan for MACD bullish crosses
- Verify uptrend (MACD > 0)
- Check price near support
- Sell 0.25 delta puts
- Exit on bearish cross
Key Takeaways
Moving Average Convergence Divergence (MACD):
- Lower indicator below price chart
- Shows trend and momentum
- Three components work together
- Signal crosses trigger trades
- Divergences warn of reversals
- Histogram shows momentum strength
- Best combined with price action
MACD is one of the most versatile lower indicators, providing both trend direction and momentum strength in an easy-to-read format. For option sellers, it excels at keeping you on the right side of the trend while warning when momentum shifts are likely. Master MACD’s signals – especially divergences and histogram patterns – to time your premium sales when probability favors reversal rather than continuation.