What Is MACD?
Let me explain the Moving Average Convergence/Divergence, or MACD, indicator directly to you. It's a tool I use to spot price trends in securities, helping you identify momentum and potential entry points for buying or selling. Developed by Gerald Appel in the 1970s, MACD remains a staple on most trading platforms from top online brokers. You calculate the MACD line by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. Then, there's a nine-period EMA of that MACD line, which we call the signal line. This setup works best with daily periods using the standard 26/12/9 settings.
What MACD Signals
MACD signals potential trades through its components. You look at the MACD line crossing above the signal line as a buy signal, and below as a sell or short signal. Common interpretations include crossovers, divergences, and rapid rises or falls. These help you gauge the strength and direction of trends without overcomplicating things.
MACD Formula
The formula is straightforward: MACD equals the 12-period EMA minus the 26-period EMA. This uses exponential moving averages, which weight recent data more heavily than simple moving averages, making MACD responsive to price changes.
Using MACD
When you apply MACD, a positive value means the 12-period EMA is above the 26-period one, showing upward momentum, and negative indicates the opposite. The histogram graphs the distance between the MACD and signal line, helping you spot peaks in bullish or bearish momentum. I often display it this way to identify overbought or oversold conditions clearly.
MACD vs. Relative Strength
Compare MACD to the Relative Strength Index (RSI), which flags overbought or oversold based on recent gains and losses, typically over 14 periods. RSI readings above 70 suggest overbought, below 30 oversold. MACD doesn't have fixed levels; instead, you assess it relatively against past price action. Both measure momentum but in different ways—MACD via EMA relationships, RSI via price velocity. They can contradict, so use them together for a fuller picture.
Limitations of MACD
MACD isn't perfect; it can give false positives, especially in sideways markets like ranges or triangles, where momentum slows without a real reversal. To counter this, confirm with trend indicators like the Average Directional Index (ADX). If ADX is above 25, a trend exists; below 20, it's ranging. Check ADX before acting on MACD signals to avoid bad trades.
MACD Crossovers
Crossovers are key: when MACD drops below the signal line, it's bearish—consider selling. Above, it's bullish—think about buying. These are stronger when aligning with the overall trend, like a bullish crossover in an uptrend confirming continuation.
MACD Divergence
Divergence occurs when MACD highs or lows don't match price highs or lows. Bullish divergence shows rising MACD lows against falling price lows, signaling potential upside if the trend is positive. Bearish is the reverse, confirming downtrends. Watch these even in opposing trends, though they're less reliable there.
Rapid Rises or Falls in MACD
Rapid MACD movements indicate overbought or oversold conditions, suggesting a pullback. Combine this with RSI for verification. The histogram works similarly, showing crossovers and divergences to time your trades.
Frequently Asked Questions About MACD
- Traders use MACD to detect shifts in price trend direction or strength by monitoring momentum changes via EMAs.
- MACD is primarily a lagging indicator based on historical data, though its histogram can sometimes predict trend changes.
- Bullish divergence happens when MACD doesn't hit new lows while price does, signaling potential upside; bearish is the opposite.
The Bottom Line
In summary, MACD is a lagging moving average indicator best for daily data, reacting quickly to price shifts. Note crossovers for signals, but always confirm with tools like RSI or price charts to ensure accuracy.
Other articles for you
Cooking the books refers to using deceptive accounting practices to make a company's financial performance appear better than it actually is.
Implicit costs are opportunity costs that represent forgone income from using owned assets internally rather than externally, without cash exchange.
Joint endorsement requires all parties to sign checks made out to multiple individuals to ensure agreement on deposit or cashing.
A KSOP is a retirement plan that merges an ESOP with a 401(k), allowing employers to match employee contributions with company stock instead of cash.
A stalking horse bid is an initial offer on a bankrupt company's assets that sets the minimum price for subsequent bids.
Top-down investing starts with analyzing broad economic factors before narrowing down to specific sectors and companies.
A banker's acceptance is a bank-guaranteed payment instrument used in international trade to minimize risks for both buyers and sellers.
Accumulated other comprehensive income tracks unrealized gains and losses on investments, pensions, and hedges in the equity section of the balance sheet until they are realized.
Exploration and production (E&P) is the initial phase in the oil and gas industry focused on finding and extracting raw hydrocarbons.
The least squares criterion is a method to find the best-fitting line for data by minimizing the sum of squared distances.