The Moving Average Convergence-Divergence (MACD) is a simple and effective indicator based on (as the name implies) moving averages. What it does is to take the longer moving average (usually the 26-day Exponential Moving Average) and subtract it from the shorter moving average (usually the 12-day Exponential Moving Average).
The reason for these moving averages (MA) is because you can tell the strength of momentum with them. The shorter EMA is faster because it’s based on 12 days, and accordingly, the longer moving average is slower, and as a result, less reactive to any price changes. A positive MACD is when the shorter EMA is above the longer EMA. Negative MACD is when the shorter EMA is below the longer EMA. The larger the divergence between the 2 MA lines, the greater the momentum (upside or downside).
There are 3 methods to use the MACD as a trading indicator.
1. Centerline Crossovers
An important line to the MACD is the centerline, or the zero line, which the MACD oscillates above and below. A bullish crossover is when the MACD crosses the centerline upwards, and a bearish crossover is when the MACD crosses the centerline downwards.
In the chart of China Animal below, the green lines mark the points of a centerline crossover.
2. Signal Line Crossovers
Another important line that is used in the MACD indicator is the signal line, which is the 9-day EMA of the MACD. Signal line crossovers are used to indicate bullish or bearish turns. A bullish crossover is when the MACD crosses the signal line upwards, and a bearish crossover is when the MACD crosses the signal line downwards.
In the chart of China Animal above, the blue lines mark the points of a signal crossover.
Sometimes, the MACD will diverge from the counter’s price movements. For example, if the counter forms a higher high, but the MACD forms a lower high. This is representative of the bullish momentum slowing down, and tells you that there’s a good chance of a reversal.
In Dapai’s chart below, a divergence is shown:
Category: Charting Indicators