Moving Average Convergence Divergence (MACD)
The moving average convergence divergence (MACD) is a momentum indicator developed by Gerald Appel, publisher of “Systems and Forecasts” in the early 1970’s. It is a trend following indicator that is based on the relationships between two moving averages of prices. The MACD measures the divergence, or convergence, between a shorter term moving average and a longer term moving average and is represented in two ways:
- A line form, and
- A histogram
Note: MACD can be pronounced as either “Mac-Dee” or M-A-C-D.
MACD is a measure of both price trend and momentum, where momentum shows the strength of the trend.
Simply put, MACD is the difference between two moving averages. It is calculated by subtracting the 26 day exponential moving average (EMA) from the 12 day EMA. A 9 day EMA of the MACD, called the “signal line”, is then plotted on the top of the MACD, and functions as a trigger for buy and sell signals.
MACD is a reliable indicator as it uses moving averages, which themselves are lagging indicators and which are, in turn, converted into a momentum oscillator by subtracting the longer term moving average from the shorter term moving average. The resulting chart forms a line that oscillates above and below zero, without any pre-set upper or lower boundaries:
- If MACD is greater than zero, it means that the short term average is higher than the longer term average, signaling an up trend.
- On the other hand, if MACD is less than zero it suggests a down trend.
Strong momentum is represented by the volatility in price, which results in a steeper slope of the MACD plot. MACD can be grouped into the centered oscillator category. Centered oscillators are those oscillators which move above and below a center (zero) line. So they move below / above the zero line.
How MACD is calculated
- Bullish / bearish moving average / center line crossovers,
- Overbought / Oversold, and
- Positive / negative divergences.
A crossover is said to occur when MACD moves above or below the zero (neutral) point, or when MACD moves above its 9 day EMA, i.e., the signal line. Thus:
- It is a signal to buy MACD crosses over above the signal line, and sell when it falls below the signal line. This crossover signal is very common but should not be solely relied upon simply because of the crossover happening. We should apply it in combination with other technical analysis tools, such as price volume relationship, in order to avoid getting whipsawed.
- Buy and sell signals are also generated when center line crossovers occur, i.e., when MACD moves above, or below, the zero line and into positive, or negative, territory. This indicates that momentum has changed; either from bullish to bearish, or from bearish to bullish.
Phase of Market to Use in
The moving average convergence divergence (MACD) is used in Trending Market.
Trading Rules and Setups
- Go long when MACD line crosses the signal line from below, with a protective stop below the latest minor low.
- Go short when the MACD line crosses the signal line from above and place a protective stop above the latest minor high.
The MACD Histogram was developed by Thomas Aspray in 1986. Aspray was looking for a means to anticipate MACD crossovers and noted that the lag of MACD on weekly charts sometimes led to missing out on important moves in a security. This was experimented by changing the duration of moving averages and found that shorter moving averages did really speed up the signals.
The MACD Histogram is a representation of the difference between MACD and its trigger line, the 9 day EMA of the MACD. This difference is plotted and is represented as a histogram, where centerline crossovers and divergences can be easily identified:
MACD Histogram = MACD line – Signal Line