MACD Explained

Last Updated on January 15, 2019 by Sultan Beardsley

As a follow up to our previous article on moving averages, we thought it would be helpful to introduce MACD to some of our newer readers.

The following article will discuss MACD as follows;

• What is MACD?

• Divergence

• Take Aways

What is MACD?

A technical analysis method developed by Gerald Appel, MACD is the abbreviation for moving average convergence/divergence. In essence MACD is used to provide insights as to direction, strength and momentum. The MACD line can be calculated by taking the 26 day EMA and subtracting it from the 12 day EMA. After this, a “signal line” (nine day EMA of the MACD) is plotted on top of the MACD line. This is used to “signal” investors of potential buy or sell points. Users of the method will typically position a buy when the the MACD passes the signal and may sell or short when MACD crosses below the signal line. Due to the nature of the calculation, a positive value is found when the 12 day EMA is above the 26 day EMA and is negative when inversely observed.

As observed in the image below, we can see the price action in relation to a cross above or below the signal line. MACD is generally plotted with a means of measuring the distance from the signal line. In this example we will use a histogram as observed. MACD being above the signal line will plot it above the base line. The same is true for the inverse.

MACD and signal line of CNAT, Source: marketmemory.com

Divergence

A bearish indicator is observed when the MACD dips below the signal line, indicating a potential sell point. Inversely the opposite remains true, meaning a cross over the signal line in an upward momentum is indicative of a potential upward movement. This is best followed when assured it has been confirmed. In order to observe the strongest indication and not enter a position at a poor time, investors are best advised to pay attention to cross overs when they are confirmed by the general trend. This can be observed in the image below (MACD purple, signal line orange)

The same remains true for bearish indications as observed in the below image. FATE chart from marketmemory.com

Divergence is observed when MACD touches highs or lows which deviate from the corresponding price. A bullish divergence is when when MACD achieves two rising lows which are in correspondence with two falling lows when observing the same price. Although this generally seen as best used when the trend is positive, some use the indicator in a negative trend as it occasionally captures a change.

 

And inversely Bearish Divergence

Source for divergence depictions: forextips.com

Take Aways

MACD is a useful tool in providing insights into potential direction, strength and momentum changes. The method is calculated using EMA and is then graphed with a “signal line.” The signal line tells investors potential bearish and bullish indicators based on MACDs position to it. Investors look to sell when MACD crosses below the signal line and buy when it crosses above. All of this data is then used by investors to dictate whether a bullish/bearish movement will continue or not based on the forecasted strength.