Moving average convergence divergence (MACD) is one of the more popular trading indicators among chart watchers, but it is rarely sufficient as a standalone tool. Instead, MACD is best used with other indicators and different forms of technical analysis. For example, support and resistance areas and candlestick chart patterns, along with the moving average convergence divergence indicator, can help identify potential market reversals.
Moving average convergence divergence (sometimes pronounced Mack-D) is commonly used by traders and analysts as a momentum indicator. The indicator consists of two exponential moving averages (EMAs)—a short-term EMA of 12 and a longer-term EMA of 26—and represents (as a histogram on the bottom of a chart) the difference between the two averages. MACD overlays the histogram with a nine-day EMA line.
- Moving average convergence divergence is a charting indicator that can be used with other forms of technical analysis to spot potential reversals.
- Support and resistance areas are commonly used with MACD to find price points where the trend might change direction.
- Candlestick chart patterns, such as the doji, can be used with moving average convergence divergence to see areas on the chart that are deemed technically significant.
Traders often use the MACD as a divergence indicator to provide an early indication of a trend reversal. For example, when the price makes a new high or low, but the MACD histogram fails to reach a new high or low, the divergence is interpreted as an indication the current trend's momentum is beginning to wane and the market may soon change direction.
Support and Resistance
Support and resistance areas can sometimes help in identifying times when a market may reverse course, and these commonly occur at market turning points. For example, if the MACD gives a divergence from price indication at an area identified as a major support or resistance level in a market, that situational fact lends further likelihood to the MACD's indication that price may soon change direction.
Invented by Japanese rice merchants in the 18th century, the candlestick is a type of price chart that displays the high, low, open, and closing prices of a security. Each bar (or candlestick) represents one period of trading, such as minutes, days, weeks, or months, and appears as a rectangle (the body), with small lines at the top or bottom (the wicks).
A myriad of trading strategies or signals are generated with candlestick charts, with some patterns on a candlestick chart notifying traders that a reversal might be at hand. For example, the pattern called the evening star is a bearish reversal pattern at the end of an uptrend, and the morning star is a bullish reversal pattern that occurs after a downtrend.
Other candlestick patterns that signal market reversals include the doji, hanging man, or bullish or bearish engulfing candle. A trader recognizing one of these candlestick patterns at the same time that the MACD shows a divergence from the market's price movement has some corroboration of indicators showing the market may be turning and changing trend.