Trading With the MACD Indicator
The Moving Average Convergence/Divergence indicator was developed by Gerald Appel in the 1970's and to this day it remains fairly popular with technical analysts. The indicator is an oscillator that measures both the direction of the trend and the strength of the trend as well as the momentum behind the movement its self. In technical analysis, indicators that measure the strength and direction of the trend are typically used in trend following trading strategies; while oscillators that measure momentum are usually used for picking market turning points – the Moving Average Convergence/Divergence (or MACD) indicator combines both of these functions and it is classed as an oscillator.
The MACD indicator works by comparing the difference between two exponential moving averages usually a 12-day EMA and a 26-day EMA. The difference between the 12-day EMA and the 26-day EMA is known as the MACD Line.
The next component that makes up the indicator is the Signal Line, which is simply a 9-day EMA of the MACD Line. The final part of the indicator is the MACD Histogram which is the MACD Line minus the Signal Line. The calculation is therefore as follows –
MACD Line = (12-day EMA – 26-day EMA)
Signal Line = 9-day EMA of MACD Line
MACD Histogram = (MACD Line – Signal Line)
An Example of the MACD Indicator
As an indicator based on moving averages the MACD is a lagging indicator, that is, it is merely showing the technical analyst a graphical representation of what has already happened. However the representation of the past produced by this indicator can make it easier to see subtle changes that one could easily miss while looking at a raw price chart with no indicators. Exponential moving averages highlight recent changes as they respond to recent changes far quicker than simple moving averages do as they give the most weight to the most recent price information.
The MACD Indicator: How to use it,
There are three main ways in which the MACD indicator is used, they are –
- The MACD Line crossing the Signal Line: Signal Line and MACD Line crossovers are the primary signals provided by the MACD indicator. The market is said to be bullish (buy) when the MACD Line crosses above the Signal Line and bearish (sell) when the MACD Line crosses below the Signal Line. The histogram will also show the two lines crossing as it is simply the difference between the two lines. When the histogram turns positive that is a bullish signal, then the histogram turns negative that is a bearish signal.
- The MACD Line crossing zero: A cross through zero happens when there is no difference between the fast and slow EMAs. When the MACD Line crosses through zero from a negative number to a positive number it is a signal that the downward momentum has faded and is considered a bullish signal. And when the MACD Line crosses through zero from a positive to a negative it is a signal that the upward momentum has faded and is considered a bearish signal. Zero crossovers are evidence of a change of trend direction, but they often happen when the market lacks the momentum needed to produce a Signal Line crossover. Usually when a zero crossover occurs a Signal Line crossover confirming the new trend will occur later.
- A discrepancy between the MACD line and the market price: A discrepancy between the MACD and the price chart is usually defined as the market price hitting a new high but the MACD not hitting a new high; or the market price hitting a new low but the MACD not hitting a new low. When the market price makes a new extreme but the indicator doesn't it is usually seen as a sign that the movement lacks real strength and the trend is set to reverse. For example, if the market price makes a new low but the indicator doesn't follow through with a new MACD low it is often interpreted as a bullish signal that the down trend is nearly over. Likewise, if the market price makes a new high but the indicator doesn't follow through with a new high that is usually interpreted as a bearish signal that the up trend has no real strength left in it and is about to reverse.
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