Moving Average Convergence Divergence (MACD)

The Moving Average Convergence Divergence (MACD) indicator has become one of the more popular computer-generated technical indicators.

The MACD, developed by Gerald Appel, is both a trend follower and a market momentum indicator. The MACD is the difference between a fast exponential moving average and a slow exponential moving average. An exponential moving average is a weighted moving average that usually assigns a greater weight to more recent price action.

The name “Moving Average Convergence Divergence” originated from the fact that the fast exponential moving average (EMA1) is continually converging toward or diverging away from the slow exponential moving average (EMA2). A third, dotted exponential moving average of the MACD (the "trigger" or the signal line) is then plotted on top of the MACD.

Note: I find interpretation easier if the histogram is displayed as well.

Parameters:

EMA1: The time period for the first exponential moving average. The default value is usually 12, referring to 12 bars of whatever timeframe plotted on the chart. (This is the fast moving average.)
EMA2: The time period for the subtracted exponential moving average. The default value is usually 26, referring to 26 bars. (This is the slow moving average.)

Trigger: The period of 9 bars for the signal line representing an additional exponential moving average.

Signal Line Crossovers

Signal line crossovers are the most common MACD signals. The signal line is a 9-day EMA of MACD. As a moving average of the indicator, it trails MACD and makes it easier to spot turns in MACD. A bullish crossover occurs when MACD turns up and crosses above the signal line. A bearish crossover occurs when 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.

Signal crossovers are quite common. As such, due diligence is required before relying on these signals. Signal line crossovers at positive or negative extremes should be viewed with caution. Even though 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.

Centreline Crossovers

Centerline crossovers are the next most common MACD signals. A bullish centerline crossover occurs when MACD 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 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. MACD will remain positive as long as there is a sustained uptrend. MACD will remain negative when there is a sustained downtrend.

Below is an example

The MACD study can be interpreted like any other trend-following analysis: One line crossing another indicates either a buy or sell signal. When the MACD crosses above the signal line, an uptrend may be starting, suggesting a buy. Conversely, the crossing below the signal line may indicate a downtrend and a sell signal. The crossover signals are more reliable when applied to weekly charts, though this indicator may be applied to daily charts for short-term trading.

The MACD can signal overbought and oversold trends, if analyzed as an oscillator that fluctuates above and below a zero line. The market is oversold (buy signal) when both lines are below zero, and it is overbought (sell signal) when the two lines are above the zero line.

The MACD can also help identify divergences between the indicator and price activity, which may signal trend reversals or trend losing momentum. A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. This can be an early signal of a downtrend losing momentum. A bullish divergence occurs when the MACD is making new highs while prices fail to reach new highs. Both of these signals are most serious when they occur at relatively overbought/oversold levels. Weekly charts are more reliable than daily for divergence analysis with the MACD indicator.

As with most other computer-generated technical indicators, the MACD should be a "secondary" indicator in your trading toolbox. It is not as important as "primary" technical indicators, such as trend lines or volume. You should use the MACD to help you to confirm signals that your primary indicators may be sending.