Developed by Gerald Appel in the late 1970s. The MACD (Moving Average Convergence/Divergence) ) is one of the simplest and most effective momentum indicators available.
The MACD turns Two trend-following indicators, Moving Averages, into a Momentum oscillator by subtracting the Longer moving average from the Shorter moving average. As a result, the MACD offers the best of both worlds : Trend following and Momentum.
The MACD is simple and reliable. It is calculated as a difference between the Fast and Slow moving averages. The historically popular is the difference between a security's 26-day and 12-day Exponential Moving Averages (EMAs). However, the MACD setting may greatly differ from a stock to stock and from a Time frame to a Time Frame. Different Moving Averages (Simple, Exponential, Weighted and etc.) could be used as well.
MACD Line : (12-day EMA - 26-day EMA)
Signal Line: 9-day EMA of MACD Line
MACD Histogram : MACD Line - Signal Line
The MACD is an oscillator and is plotted as a Line that moves above and below Zero line (Center line).
On index and stock charts, MACD consists of three lines - MACD itself, Exponential Moving Average applied to MACD and used as a Signal Line and MACD Histogram. The MACD-Histogram represents the difference between the MACD and its signals line (EMA). If the value of MACD is larger than the value of its EMA signal, then the value on the MACD-Histogram will be positive. Conversely, if the value of MACD is less than its EMA signal, then the value on the MACD-Histogram will be negative. The MACD histogram makes centerline crossovers and divergences more easily identifiable.
The MACD fluctuates Above and Below the zero line as the Moving Averages converge, cross and diverge. Traders can look for signal line crossovers, centerline crossovers and divergences to generate signals. Because the MACD is unbounded, it is not particularly useful for identifying Overbought and Oversold levels.
Traders also watch for a move above or below the zero line because this signals the position of the short-term average relative to the long-term average. When the MACD is above zero, the short-term average is above the long-term average, which signals upward momentum. The opposite is true when the MACD is below zero.
Signal Line Crossovers
Signal line crossovers are the most common MACD signals. The signal line is a 9-day EMA of the MACD Line. As a moving average of the indicator, it trails the MACD and makes it easier to spot MACD turns. A bullish crossover occurs when the MACD turns up and crosses above the signal line. A bearish crossover occurs when the MACD turns down and crosses below the signal line. Crossovers can last a few days or a few weeks, it all depends on the strength of the move.
Due diligence is required before relying on these common signals. Signal line crossovers at positive or negative extremes should be viewed with caution. Even though the MACD does not have upper and lower limits, chartists can estimate historical extremes with a simple visual assessment. It takes a strong move in the underlying security to push momentum to an extreme. Even though the move may continue, momentum is likely to slow and this will usually produce a signal line crossover at the extremities. Volatility in the underlying security can also increase the number of crossovers.
Centerline Crossovers
Centerline crossovers are the next most common MACD signals. A bullish centerline crossover occurs when the MACD Line moves above the zero line to turn positive. This happens when the 12-day EMA of the underlying security moves above the 26-day EMA. A bearish centerline crossover occurs when the MACD moves below the zero line to turn negative. This happens when the 12-day EMA moves below the 26-day EMA.
Centerline crossovers can last a few days or a few months. It all depends on the strength of the trend. The MACD will remain positive as long as there is a sustained uptrend. The MACD will remain negative when there is a sustained downtrend.
Divergences
Divergences form when the MACD diverges from the price action of the underlying security.
When the security price diverges from the MACD, it signals the end of the current trend. For example, a stock price that is rising and a MACD indicator that is falling could mean that the rally is about to end. Conversely, if a stock price is falling and the MACD is rising, it could mean that a bullish reversal could occur in the near-term. Traders often use divergence in conjunction with other technical indicators to find opportunities
A Bullish divergence forms when a security records a lower low and the MACD forms a higher low. The lower low in the security affirms the current downtrend, but the higher low in the MACD shows less downside momentum. Despite less downside momentum, downside momentum is still outpacing upside momentum as long as the MACD remains in negative territory. Slowing downside momentum can sometimes foreshadow a trend reversal or a sizable rally.
A Bearish divergence forms when a security records a higher high and the MACD Line forms a lower high. The higher high in the security is normal for an uptrend, but the lower high in the MACD shows less upside momentum. Even though upside momentum may be less, upside momentum is still outpacing downside momentum as long as the MACD is positive. Waning upward momentum can sometimes foreshadow a trend reversal or sizable decline.
Dramatic Rise
When the MACD rises dramatically - that is, the shorter moving average pulls away from the longer-term moving average - it is a signal that the security is overbought and will soon return to normal levels. Traders will often combine this analysis with the Relative Strength Index (RSI) or Other Technical indicators to verify Overbought or Oversold conditions.
The MACD indicator is special because it brings together momentum and trend in one indicator. This unique blend of Trend and Momentum can be applied to daily, weekly or monthly charts. The standard setting for MACD is the difference between the 12 and 26-period EMAs. Chartists looking for more sensitivity may try a shorter short-term moving average and a longer long-term moving average. MACD(5,35,5) is more sensitive than MACD(12,26,9) and might be better suited for weekly charts. Chartists looking for less sensitivity may consider lengthening the moving averages. A less sensitive MACD will still oscillate above/below zero, but the centerline crossovers and signal line crossovers will be less frequent.
The MACD can be set as an indicator above, below or behind a security's price plot. Placing the MACD “behind” the price plot makes it easy to compare momentum movements with price movements. Once the indicator is chosen from the drop-down menu, the default parameter setting appears: (12,26,9).
These parameters can be adjusted to increase sensitivity or decrease sensitivity. The MACD Histogram appears with the indicator or can be added as a separate indicator. Setting the signal line to 1 or leaving it blank, i.e. (12,26,1) or (12,26), will remove the MACD Histogram and the signal line. A separate signal line, without the histogram, can be added by choosing “Exp. Moving Avg” from the Advanced Options Overlays menu.
Finally, remember that the MACD Line is calculated using the actual difference between Two Moving Averages.
This means MACD values are dependent on the price of the underlying security.
