Moving Averages combined with Convergence and Divergence – that’s how you can define the MACD (pronounced “M-A-C-D” or “Mac-Dee”, like Mcdonalds), another widely used technical indicator. The specific thing that makes it stand out and hold a loyal following is that it provides signals in a clear way by interpreting two different moving averages and turning the difference between them into a momentum oscillator.
The indicator has three components:
- The MACD Line – it’s calculated by subtracting the 26-day Exponential Moving Average (EMA) from the 12-day EMA.
- A 9-day EMA is also calculated in the same chart and is called a Signal Line. When the two cross this serves as a buy or sell signal.
- The MACD Histogram represents the difference between the MACD and the Signal Line. When it’s positive that means the MACD Line is above the Signal Line and vice versa.
Here’s the formula these three variables are calculated by:
MACD Line: (12-day EMA – 26-day EMA)
Signal Line: 9-day EMA of MACD Line
MACD Histogram: MACD Line – Signal Line
The indicator moves above and below a zero line, so its focus is not on overbought or oversold levels (like the RSI), as it doesn’t have any borders on its top and bottom.
The number of days used for creating the MACD are what its creator Gerald Appel developed in 1979 and are the most widely used set but they can be changed to suit different time frames, trading styles and instruments. This is usually done before activating the MACD from the indicator list of your charting or trading platform.
Now we reach something many consider to be a trickier part. What are convergence and divergence, what do these seemingly hard words mean. They’re actually not that hard to understand:
Convergence – this is when the moving averages are moving closer and closer to each other
Divergence – when the moving averages are moving further apart.
Interpreting the MACD focuses on when these two things occur. The 12-day moving average responds to shorter term development and should catch any recent spikes or drops, while the 26-day is slower and in theory aims at pointing at more stable trends that can be seen over the course of the last month or so.
Bullish signals happen when the 12-day EMA moves above the 26-day EMA which is also represented by a histogram bar above the zero line. Bearish signals work the other way around – the 12-day moves below the 26-day and we get a bar pointing downwards.
The momentum of these signals is signified by the increase of the bars in the histogram – the more they increase, the stronger the move is perceived to be.
The MACD is known to be a two-in-one indicator and that’s why many traders like it but it does have its weaknesses. One of them is that it doesn’t take into consideration support and resistance levels as it has no way of interpreting the chart itself. Another thing to keep in mind is that its sensitivity has to be adapted to the volatility of the market – the 9, 12 and 26 day values were derived from data that covered many years. But different trading periods have higher and lower volatility for which the indicator may need some adjustment.