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Moving Average Convergence-Divergence Indicator

The Moving Average Convergence-Divergence indicator (MACD), or ‘Mac D’ as it is usually referred to, was devised by Gerald Appel a US investment manager in 1977. It is one of the most popular technical oscillators and uses a moving average crossover method to generate trading signals by measuring price momentum in trending markets. Like all moving average-based indicators, the MACD is a lagging indicator.

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.

Definition

The MACD indicator consists of two lines:

  • MACD line – The 12-day EMA less the 26-day EMA.
  • Signal line – A 9-day EMA of the MACD line.

The MACD is the difference between two exponential moving averages (EMAs), which are conventionally the 12- day and 26-day. The signal line is a 9-day EMA of the MACD line. It is this line that generates trading signals.

MACD histogram on the same chart. This usually measures the difference between the MACD and signal lines.

Plotted around a zero line, a positive MACD indicates that average prices over the past 12 days are higher than average prices over the past 26 days.

Trading Signals

Plotted around a zero line, a positive MACD indicates that average prices over the past 12 days are higher than average prices over the past 26 days and so signal a bullish market (and vice versa). However, using crosses above and below the zero line is a crude and ineffective method of generating trading signals. Nevertheless, if the MACD remains above or below the zero line for long periods, this suggests that the underlying market trend is either positive or negative so any countertrend signals generate by the lines themselves should be treated with caution.

As usual with all technical indicators and oscillators, traders should be aware of extreme readings, divergence with price, and trends within the indicator itself i.e. descending peaks, rising troughs and movement within channel lines.

Trading signals are most commonly generate by the MACD crossing above or below the signal line:

  • A cross of the MACD above the signal line – BUY.
  • A cross of the MACD below the signal line – SELL.

MACD Technical Indicator

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.

Tips

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.

What the Experts say

‘The MACD indicator is especially effective with longer-term trading strategies (with the Dow) but over the short-term, is not profitable.’ – Robert Colby in his ‘Encyclopedia of Technical Market Indicators’.

‘The MACD works particularly well in the FX markets. It allows you to enter trades with price momentum on your side.’ – Christian Bendixen, Bay Crest Partners.

‘The MACD indicator is a fantastic tool for identifying important price swings. The common parameters (13, 26 and 9 period moving averages) can give signals that are too frequent on a daily bar chart, so I have begun to use 21, 100 and 200 period moving averages to capture more important intermediate-term shifts.’ – Katie Stockton, MKM Partners.

‘When I see a monthly MACD crossover that does not occur very often, say every few years, I pay attention. Same goes for the monthly parabolic and double-top formations that tend to have lasting implications.’ – Jeff Hochman, Fidelity Investments.

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