How a Technical Analyst Uses Moving Average Convergence Divergence

The Moving Average Convergence Divergence (MACD), developed by Gerald Appel in the 1970s, is a popular momentum indicator used by technical analysts. The MACD indicator provides macd traders and investors with a measure of short-term momentum compared to longer term momentum, which gives an an indication of the current direction of momentum.

The MACD indicator is comprised of two Exponential Moving Averages (EMA), that measure the price momentum of a security. The MACD is typically calculated by subtracting the (“slow”) 26-day EMA from the (“fast”) 12-day EMA. The MACD line is the difference between the two EMAs plotted against a centerline.

Plotted beside the MACD line is a nine-day EMA of the MACD, which is called the “Signal line”. This Signal line is used by traders and investors as a trigger for buy and sell signals. The common buy signal comes from the indicator when the MACD line crosses above the Signal line, and the common sell signal is when the MACD crosses below the Signal line.

Traders also watch for a move above or below the centerline as this signals the position of the fast moving average relative to the slow moving average. When the MACD line is in positive territory it is telling us that the fast moving average is exceeding the slow moving average and therefore there is upward momentum in the price. Conversely, when the MACD line is in negative territory it is telling us that the fast moving average is below the slow moving average and therefore there is downward momentum in the price. When the MACD line crosses over the centerline it is telling us that there is a crossing in the moving averages, with one now exceeding the other.

Traders also look for divergence patterns between the MACD and the price movement of the security. A bullish divergence forms when the price of the security records a lower low but the MACD forms a higher low. The lower low in the price of the security confirms the current downtrend is in place, but the higher low in the MACD shows less downside momentum. The slowing of downside momentum can precede a trend reversal or a sizable rally. A bearish divergence forms when the price of a security records a higher high but the MACD Line forms a lower high. The higher high in the price of the security is normal for an uptrend, but the lower high in the MACD shows less upside momentum. Weakening upward momentum can precede a trend reversal or sizable decline. Bullish and bearish divergences should be taken with caution however. Bullish divergences occur often in a strong downtrend and bearish divergences often occur in a strong uptrend.

Thomas Aspray added to the visual aspect of the MACD by introducing a histogram in 1986, which highlights the difference between the MACD line and the Signal line. The histogram will be in positive territory when the MACD Line is above the Signal line and will be in negative territory when the MACD Line is below its Signal line. The higher the histogram bars are (either in a positive or negative direction), the more momentum there is behind the direction in which the bars point.

The typical time periods used in the calculation of the MACD and Signal lines are 12, 26 and 9 are, although a trader or investor may use alternative time periods depending upon trading style and objectives. Where the price movements of securities are more volatile the MACD can be calculated with shorter term averages, while with less volatile securities longer averages can be used. Note that it is the closing prices of a security that are used in the calculation of the MACD.

Leave a Reply

Your email address will not be published. Required fields are marked *