A moving average convergence-divergence indicator (MACD) is a momentum indicator that follows trends. Find out how it can be used to enhance investment knowledge.
The moving average convergence-divergence indicator (MACD) is a popular momentum indicator that technical analysts use to identify whether a market is trending up or down. The indicator shows the relationship between two moving averages used in price action analysis.
MACD uses three numbers for its settings. The first is the number used to calculate the faster-moving average. The second represents a number used to calculate the slower moving average. The third is the number that calculates the difference between the faster and slower moving averages.
Commonly used parameters in most MACD indicators are 12, 26, and 9, with 12 representing the faster moving average, 26 the slower moving average, and 9 the difference of the two plotted by vertical lines represented by a histogram.
The two lines that appear in a MACD chart are not purely moving averages, but the difference between the two moving averages. The histogram, on the other hand, plots the difference between the faster moving average and the slower moving average.
I. How To Use MACD Indicator
The presence of two moving averages means they always react at different speeds to price movements. The fast-moving average will always be the first to react to price changes, while the slower moving average lags.
The moving average convergence-divergence indicator is thus an ideal indicator for identifying trend changes with regards to price movements. For instance, whenever a new trend starts to develop, the faster moving average would react faster and cross the slower moving average.
Depending on the strength of the emerging trend, the faster moving average line would start diverging from the slower moving average line, affirming the formation of a new trend. When a crossover happens, the histogram temporarily disappears, as the difference between the two moving averages is zero. The histogram gets bigger as the fast line moves away from the slow line, indicating a strong trend.
II. MACD Buy and Sell Signals
The MACD indicator can also be relied upon to provide buy and sell signals depending on the crossovers that occur in the chart. Whenever the MACD line, which is the difference between the faster-moving and shorter-term line crosses above the zero lines from below, that’s interpreted as a buy signal.
Conversely, whenever the MACD line crosses the centerline of the histogram from above and starts edging lower, that’s a sell signal.
III. MACD Histogram
As discussed above, a MACD histogram is the difference between the MACD line and the MACD signal line.
The two important points to note in a MACD histogram are convergence and divergence. Convergence occurs whenever there is a change in direction or a slowdown in a prevailing trend. When this happens, the MACD line will get closer to the MACD signal line, indicating a potential trend reversal.
Divergence, on the other hand, occurs whenever the MACD histogram is increasing in height. Such situations signal strengthening of an underlying trend. The price of an underlying asset will continue to move in the direction of the trend.
A MACD histogram will signal a potential buy opportunity when it is below the zero line and starts to converge towards the zero lines. Conversely, the histogram will signal a sell opportunity when it is above the zero lines and starts to converge towards the zero lines.
IV. MACD Divergences
MACD bearish divergence occurs when the indicator suggests that the price of an underlying asset should be going down, but the price continues to trade in an uptrend instead.
Conversely, a bullish divergence occurs when the indicator indicates that the price should heading higher, but the actual price continues to move lower.
