MACD (Moving Average Convergence Divergence)

By Vikram 18 Comments 13 Sept 2018

MACD (Moving Average Convergence Divergence)

An Introduction

MACD- Moving average convergence divergence is one of the most reliable trading indicator used in technical analysis of stock prices, created by Gerald Appel . MACD indicator demonstrates the duration of a trend, strength, direction, and momentum of the price changes which helps in foreseeing a perfect entry/exit point for a trade. It is supposed to reveal changes in the strength, direction, momentum, and duration of a trend in a stock's price.

MACD indicator is a momentum oscillator primarily used to trade trends. Although it is an oscillator, it is not typically used to identify over bought or oversold conditions. It appears on the chart as two lines which oscillate without boundaries. The crossover of the two lines give trading signals similar to a two moving average system.

MACD such a valuable tool for technical analysis, it is almost like two indicators in one. It can help to identify not just trends, but it can measure momentum as well. It takes two separate lagging indicators and adds the aspect of momentum which is much more active or predictive That kind of versatility is why it has been and is used by trader's and analysts across the whole finance market.

Despite MACD's obvious attributes, just like with any indicator, the trader or analyst needs to exercise caution. There are just some things that MACD doesn't do well which may tempt a trader regardless. Most notably, traders may be tempted into using MACD as a way to find overbought or oversold conditions. With sufficient time and experience, almost anybody who wants to analyze chart data should be able to make good use out of the MACD.

MACD- Calculation

MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average.
MACD is calculated by taking difference between 12 day Exponential Moving Average (EMA) and 26 day EMA. A positive MACD means the 12-period EMA is above the 26-period EMA.

A trigger for buy or sell signals can be obtained when a 9 day EMA called the “signal line” is plotted on top of the MACD. Traders typically use the MACD as a simple crossover, so when the MACD crosses the signal line, they tend to buy or sell based on which way the cross appears.When MACD turns up and crosses over the signal line, bullish crossover occurs. Bearish crossover occurs when MACD turns down below the signal line. The difference between those two values can be plotted by a Histogram.

Calculation

MACD line = 12 day EMA Minus 26 day EMA
Signal line = 9 day EMA of MACD line
MACD Histogram = MACD line Minus Signal line

The equation for calculating a Trailing 12-day average is ,

calculation of Trailing 12-day average

The calculations are described using this image:-


 MACD - Calculation

MACD - Using with Charts

To full understand the concept of MACD indicator, it is first necessary to know each of the indicator's components :-

The Three Major Components:-

  • The MACD Line:- MACD Line is a result of taking a longer term EMA and subtracting it from a shorter term EMA. The most commonly used values are 26 days for the longer term EMA and 12 days for the shorter term EMA, but it is the trader's choice.
  • The Signal Line:- The Signal Line is an EMA of the MACD Line described in Component 1. The trader can choose what period length EMA to use for the Signal Line however 9 is the most common.
  • The MACD Histogram:- As time advances, the difference between the MACD Line and Signal Line will continually differ. The MACD histogram takes that difference and plots it into an easily readable histogram. The difference between the two lines oscillates around a Zero Line.

Take a Look at the MACD Chart below Showing these three major components in detailed view:-


MACD Chart
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