What is MACD - Moving Average Convergence-Divergence?
It is one of the most popular indicators in Technical Analysis as it is easy to use as well as one of the most reliable indicators.
MACD is calculated by subtracting a long term exponential moving average (EMA) of the stock from the short term EMA. Usually 26 day EMA and 12 day EMA are chosen for the same. As the moving averages cross, converge and diverge, MACD fluctuates above and below the zero line. 9 day EMA of MACD is used as signal line. MACD is basically lagging indicator as it is based on moving averages but crossovers of MACD and Signal line is used to give signals far in advance of actual crossings of MACD and Zero line. The difference between MACD and Signal line is shown as bar-graph or histogram on the charts.
MACD basically compares EMAs of different periods and thus is used to indicate both changes in trend as well as momentum. So, it signals changes in trend strength, direction and duration as well as momentum of the stock.
MACD Signals has been interpreted in many ways. Some of the most popular ones are :
- Bullish Signal-line crossover - When MACD crosses over Signal line from below, it is Buy.
- Bearish Signal-line crossover - when MACD moves below Signal line from above, it is Sell.
The above is also shown on the chart by histogram which is zero at the time of cross over. Histogram also helps in suggesting in advance that the crossover may be approaching if it starts getting narrower. If histogram starts widening, it indicates that the trend is getting stronger. Bullish crossover should occur when MACD is below zero line and Bearish crossover should occur when MACD is above zero line.
- Bullish Zero line crossover - when MACD crosses over zero line from below, it is Buy.
- Bearish Zero line crossover - when MACD moves below zero line from above, it is Sell.
Zero line crossovers are considered more reliable but they suffer from lag as the trend has already started.
- Bullish MACD Divergence - When stock makes higher low and MACD makes lower low, it signals trend reversal and it is Buy.
- Bearish MACD Divergence - When stock makes higher high and MACD makes lower high, it signals trend reversal and it is Sell.
Note:Divergence Signals need to handled with caution as Bearish Divergence happens commonly in strong Uptrends and similarly Bullish Divergence happens commonly in strong downtrends.
MACD can also give false signals at times especially when market is volatile. MACD signals should be verified with other indicators.