By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.com
The moving average convergence divergence (MACD) is one of the most well known and used indicators in technical analysis. It is used to signal both the trend and momentum behind a security.
The MACD indicator is comprised of two exponential moving averages (EMA), covering two different time periods, which help to measure momentum in the security. The MACD is simply the difference between these two moving averages, which in practice are generally a 12-period and 26-period EMA. The MACD is plotted against a centerline along with a nine-period EMA, which is referred to as the "signal line".
The idea behind this momentum indicator is to measure short-term momentum compared to long-term momentum to help determine the future direction of the asset.
The most commonly used moving average values are 26-day and 12-day EMAs for the MACD calculation and a nine-day EMA of the MACD for the signal line.
These values can be adjusted to meet the needs of the technician and the security. For more volatile securities shorter term averages are used while less volatile securities should have longer averages.
Another aspect to the MACD indicator that is often found on charts is the MACD histogram. The histogram is plotted on the centerline and represented by bars. Each bar is the difference between the MACD and the signal line or, in most cases, the nine-day EMA. The higher the bars are in either direction the more momentum behind the direction the bars point.
The buy-and-sell signals in regard to the MACD are formed either because of crossovers or divergence.
The first signal that is formed by the MACD is when the MACD line crosses the signal line, which is the EMA of the MACD. When the MACD crosses the signal line in an upward direction it is a bullish sign as the asset is gaining upward momentum. When the MACD is gaining upward momentum it reflects that the shorter term moving average (12-day) is increasing at a faster rate than the (26-day) and that the trend is starting to strengthen in the upward direction.
When the MACD crosses below the signal line it suggests that upward momentum is weakening with downward pressure increasing. It is signals that the shorter term momentum is falling faster than the longer term average, signaling an increase in short-term selling.
The second signal, which also deals with crossovers, occurs when the MACD crosses the centerline. If the MACD line crosses the centerline in an upward direction it signals upward momentum. This upward crossover can also be seen on the price chart at the exact movement when the 12-day moving average is crossing the 26-day in an upward direction.
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Downward momentum is signaled when the MACD falls below the centerline. This is the point in which the 12-day moving average falls below the 26-day moving average - a sign of increased downward momentum.
The third signal that is formed by the MACD line is when it diverges from the price movement in the security. This signals that the momentum in the security is moving in the opposite direction of the true trend and suggests a future weakening in the price trend. If the MACD line is moving in an upward direction while the price is moving downward it is a bullish sign. The opposite is true if the MACD line is moving downward while the price is moving upward.
The MACD indicator is by far one of the most well known and commonly used in technical analysis. It is important that anyone using technical analysis become well versed in this momentum indicator.
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