Moving Average Convergence Divergence

From Traderpedia

Definition:
An indicator that follows the difference between a pair of moving averages.


Developed by Gerald Appel, MACD (moving average convergence divergence) is a trend following momentum indicator that shows the relationship between two moving averages of prices.

[edit] Calculation

To calculate the MACD subtract the 26-day exponential moving average (EMA) from a 12-day EMA. A 9-day dotted EMA of the MACD called the signal line is then plotted on top of the MACD. Other lengths of average can be used, but 9-12-26 is the most common "standard" setting.

[edit] Function

MACD measures the difference between two moving averages. A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing and this would be considered bullish. If MACD is negative and declining further, then the negative gap between the faster moving average and the slower moving average is expanding. Downward momentum is accelerating and this would be considered bearish.

[edit] Application

There are 3 common methods to interpret the MACD1:

  1. Crossovers - When the MACD falls below the signal line it is a signal to sell. Vice versa when the MACD rises above the signal line.
  1. Divergence - When the security diverges from the MACD it may signal the end of the current trend. For instance, price may continue to make higher highs while MACD makes lower highs. This is an example of bearish, or negative divergence and a warning that the up trend may soon be finished.
  1. Overbought/Oversold - When the MACD rises dramatically (shorter moving average pulling away from longer term moving average) it is a signal the security is overbought and will soon return to normal levels.