MOVING AVERAGE CONVERGENCE DIVERGENCE (MACD)

(MACD)
Technical Indicator
Moving Average Convergence Divergence (MACD)
INTRODUCTION OF MACD

Learning to trade in the direction of the short-term momentum can be a difficult task at the best of times, but it is exponentially more difficult when one is unaware of the appropriate tools that can help. This article will focus on the most popular indicator used in technical analysis, the Moving Average Convergence Divergence (MACD). This technical analysis indicator, developed by Gerald Appel in the late seventies, Moving Average Convergence-Divergence is one of the simplest and most effective momentum indicators available.

This technical analysis indicator, developed by Gerald Appel in the late seventies, Moving Average Convergence-Divergence is one of the simplest and most effective momentum indicators available.

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 momentum oscillator offers the best of both worlds: trend following and momentum. It 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. As the indicator is unbounded, it is not particularly useful for identifying overbought and oversold levels.

HISTORY OF MACD

The MACD was invented by Gerald Appel in the 1970’s. Thomas Aspray added a histogram to the indicator in 1986, as a means to anticipate the oscillators crossovers, an indicator of important moves in the underlying security.

MACD

Gerald Appel is a professional money manager, with over 30 years trading experience. He is one of the most prolific inventors of technical trading tools, many of which have become popular worldwide. He is the originator of MACD (Moving Average Convergence-Divergence) and MACD-Histogram, considered essential trading tools by many traders.

Tom Aspray found that MACD signals often lagged important market moves, especially when applied to weekly charts. He first experimented with changing the moving averages and found that shorter moving averages did indeed speed up the signals. However, he was looking for a means to anticipate MACD crossovers and came up with the MACD Histogram.

The MACD Histogram

The MACD Histogram is useful for anticipating changes in trend.

Overview

The MACD Histogram (MACD-H) consists of vertical bars showing the difference between the MACD line and its signal line.

• A change in the MACD-H will usually precede any changes in MACD.

• Signals are generated by direction, zero line crossovers and divergence from MACD.

• As an indicator of an indicator, MACD-H should be compared with MACD rather than with the price action of the underlying market.

MACD-H is used with MACD as a complementary indicator.

What Is Moving Average Convergence Divergence – MACD?

Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.

Definition of MACD

The MACD is a trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the “signal line”, is then plotted on top of the MACD, functioning as a trigger for buy and sell signals.

More simply put, the MACD is a computation of the difference between two exponential moving averages (EMAs) of closing prices. This difference is charted over time, alongside a moving average of the difference. The divergence between the two is shown as a histogram or bar graph.

Exponential moving averages highlight recent changes in a stock’s price. By comparing EMAs of different periods, the MACD line illustrates changes in the trend of a stock. Then by comparing that difference to an average, an analyst can chart subtle shifts in the stock’s trend.

Since the MACD is based on moving averages, it is inherently a lagging indicator. As a metric of price trends, the MACD is less useful for stocks that are not trending or are trading erratically.

Note that the term “MACD” is used both generally, to refer to the indicator as a whole, and specifically, to the MACD line itself.

With a MACD chart, you will usually see three numbers that are used for its settings.

● The first is the number of periods that is used to calculate the faster-moving average.

● The second is the number of periods that is used in the slower moving average.

● And the third is the number of bars that is used to calculate the moving average of the difference between the faster and slower moving average.

For example, if you were to see “12, 26, 9” as the MACD parameters (which is usually the default setting for most charting software), this is how you would interpret it:

● The 12 represents the previous 12 bars of the faster moving average.

● The 26 represents the previous 26 bars of the slower moving average.

● The 9 represents the previous 9 bars of the difference between the two moving averages. This is plotted by vertical lines called a Histogram (the green lines in the chart above).

How this indicator works

● MACD crossing above zero is considered bullish, while crossing below zero is bearish. Secondly, when MACD turns up from below zero it is considered bullish. When it turns down from above zero it is considered bearish.

● When the MACD line crosses from below to above the signal line, the indicator is considered bullish. The further below the zero line the stronger the signal.

● When the MACD line crosses from above to below the signal line, the indicator is considered bearish. The further above the zero line the stronger the signal.

● During trading ranges the MACD will whipsaw, with the fast line crossing back and forth across the signal line. Users of the MACD generally avoid trading in this situation or close positions to reduce volatility within the portfolio.

● Divergence between the MACD and the price action is a stronger signal when it confirms the crossover signals.

Description: The main points for an MACD indicator are: a) Time period or interval – which the user can define. Commonly used time periods are: Short-term intervals – 3, 5, 7, 9, 11, 12, 14, 15-day intervals, but 9-day and 12-day durations are more popular Long-term intervals – 21, 26, 30, 45, 50, 90, 200-day intervals; 26-day & 50-day intervals are more popular b) Momentum oscillator line or divergence or MACD line – which can be simple plotting of ‘divergence’ or difference between two interval moving averages c) Signal Line – which is exponential moving average of divergence data e.g. 9-day EMA d) Normally a combination of 12-day and 26-day EMA of prices and 9-day EMA of divergence data is used, but these values can be changed depending on the trading goal and factors e) The above data is then plotted on a chart, where the X- axis is for time and Y-axis is price, to get MACD line, signal line and histogram for the difference between the MACD and signal line, which is shown below the X-axis
Example:

Description:

16px;”>Take the 12-day and 26-day exponential moving averages of closing prices of a security. To calculate the exponential moving average of closing prices, you need to take the weighted calculation of simple moving averages, where the weighing multiplier needs to be calculated. For calculation, refer to the exponential moving average concept. Then both the EMA data difference will be taken and used to draw an MACD line for the said duration and plotted as a line graph. This area is below the time axis and is divided by the 0 axis or called as centreline to show negative and positive. Then nine-day EMA will be calculated for MACD data in the same manner as above, which is called the ‘signal line’. Then a bar graph or histogram is drawn in the same area where the bar length shows movement variation in the MACD line and the signal line at single-point. 

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