The MACD indicator is a technical analysis tool used to identify trend reversals and measure a trend’s strength. It can be used on all time frames, from intraday to long-term charts.
This lesson will cover everything you need to know about the MACD indicator, its uses, benefits, and drawbacks.
What is MACD?
The MACD indicator is a technical analysis tool that can help traders identify trend changes and potential reversals in the market. It comprises two lines, the MACD line and the signal line, which indicate buy and sell signals. The difference between these two MACD lines is plotted as the MACD histogram.
Gerald Appel created the Moving Average Convergence Divergence (MACD) indicator. He is a well-known technical analyst and trader who has written several books on technical analysis and trading.
Updated MACD Lesson
What does MACD mean?
MACD is an acronym for Moving Average Convergence Divergence. MACD helps traders visualize the relationship between two moving average lines, which aids in spotting trend reversals. This, in turn, provides potential buy and sell signals.
The MACD line is a smoothed moving average of the prices, while the signal line is a simple moving average of the MACD line. When the MACD line crosses over the signal line, it indicates a buy signal. Conversely, when the MACD line crosses under the signal line, it indicates a sell signal.
How to use the MACD indicator?
The MACD stock chart indicator measures the momentum of a security’s price movements. The indicator comprises two exponential moving averages (EMAs), which are used to calculate the difference between the closing prices of a security over a given period. The MACD indicator is typically used to identify trends and generate buy and sell signals.
A MACD Chart with Explanation
The MACD indicator can be a helpful tool for traders in identifying potential trend changes and reversals in the market. However, it is important to note that the indicator should not be used alone but in conjunction with other technical indicators and fundamental analysis.
How do I interpret the MACD?
The MACD line measures the difference between the 12-day EMA and 26-day EMA. The MACD histogram measures the distance between the MACD line and the signal line. A buy signal is generated when the MACD line crosses above the signal line, and a sell signal is generated when the MACD line crosses below the signal line. The histogram can identify overbought and oversold conditions and generate buy and sell signals.
How is MACD calculated?
The MACD indicator is calculated by subtracting the 26-day EMA from the 12-day EMA. The resulting line is then plotted on a chart along with a 9-day EMA of the MACD, which is called the “signal line.”
MACD buy and sell signals are generated when the MACD line crosses above or below the signal line.
A buy signal is generated when the MACD line crosses above the signal line, and a sell signal is generated when the MACD line crosses below the signal line.
The MACD indicator can also measure the strength of a security’s price movement.
The MACD Histogram
The MACD Histogram measures the distance between the MACD line and the signal line. The histogram is positive when the MACD line is above the signal line and negative when the MACD line is below the signal line. The histogram can identify overbought and oversold conditions and generate buy and sell signals.
The MACD stock chart indicator is a tool that can be used to help traders make informed investment decisions. The MACD measures the difference between two moving averages and can be used to identify trend changes and potential reversals. Traders can use the MACD to generate buy and sell signals, and it can also be used to determine the strength of a trend. The MACD is a popular indicator among traders and can be a valuable tool for those who know how to interpret it correctly.
What is a MACD crossover?
A MACD crossover is when the MACD line crosses above or below the signal line. A buy signal is generated when the MACD line crosses above the signal line, and a sell signal is generated when the MACD line crosses below the signal line.
MACD’s five settings
- A short length or fast-moving average = 12.
- A long length or slow-moving average =26.
- Period or signal smoothing = 9 (the moving average of the difference between the short and long above).
- Select a simple or exponential moving average – use the EMA for a quicker reacting MACD indicator.
- Plot as a histogram so you can use MACD divergences.
Best MACD Settings
The best MACD settings for day traders or long-term investors are different. For long-term investors, it is fine to use the default settings of 12-26-9; also, 10-30-5 is popular.
Best MACD Settings for Day Traders
Day traders using 1-minute charts will need to shorten the MACD settings to 5-35-5. Experimenting with the settings to see which works best for their trading style and timeframe is important.
Experiment and view charts on different timeframes to test if the indicator works during different time frames.
What is a MACD Divergence?
The MACD divergence is a simple technique that can be used to identify trend reversals and trading opportunities. The divergence is created when the price of a security moves in one direction while the MACD line moves in another direction.
MACD Bullish Divergence
A bullish divergence occurs when the price of a security falls while the MACD line rises. This indicates that the selling pressure is decreasing, and a reversal may be imminent.
MACD Bearish Divergence
A bearish divergence occurs when the price of a security rises while the MACD line falls. This indicates that the buying pressure is decreasing, and a reversal may be imminent.
MACD Divergence Example
We will use a practical example to see the usage of MACD in real stock. Take a look at the Netflix (NFLX) Learning Chart below. Here, we have a MACD configured with 10, 30, 5, and a simple moving average, and this is a 2-day (per bar) chart.
The trick with MACD is to look at the trend; it is a powerful indicator when you compare the direction of the MACD Mountains with the Price Movement.
MACD Bullish & Bearish Divergences Explained
MACD bullish and bearish divergences are uncovered when the MACD histogram moves in the opposite direction to the stock price.
In the chart above, 5 points explain MACD divergences.
1. The stock price is increasing
We see a significant stock price increase of almost 100% at point one.
2. Emergence of a bearish divergence
At point two, although the price doubled (point 1), the MACD made lower lows a “bearish divergence.” We see a change in the MACD from positive to negative, and the towering mountain (below the zero line) forms. MACD is an oscillating indicator and, as such, is always tied to the Zero line in the middle.
3. A medium-term stock price decline
The stock price is declining. Here, we see a sharp decline in price for the rest of 2008 until November. Using a trend line to show this helps us visualize the direction easier.
4. A bullish divergence
Bullish divergence: At the same time, the price is declining; we see a longer-term Positive Divergence occurring from June to December. This means the sellers’ “Gas in the tank” is slowly decreasing. However, we should not have waited until December to buy the stock; that would have been too late. Instead, we would look to point five.
5. MACD buy signal
Buy Signal: MACD broke through the line of resistance: here, we see the MACD breaking sharply past its previous high. I plotted a Trend Line in Orange to show this clearly.
If you had used MACD as your BUY SIGNAL, you would have profited by 56% in 4 months.
Summary
The MACD indicator is a versatile tool that can be used to identify trends, generate buy and sell signals, and measure the strength of a security’s price movement. Traders should use the indicator with other technical indicators to confirm signals and make sound trading decisions.