MACD (Pronounced Mac-Dee) is the short abbreviation for the moving average convergence/divergence technical indicator. The MACD is a trading indicator used in technical analysis to filter and trade the momentum of price action on a chart. It was created by the late Gerald Appel in the late 1970s as a tool for technical analysts. It was created to visually show changes in price strength, direction, momentum, and duration for trends and swings in price action on a chart.
The MACD is a simple visual momentum indicator. The MACD takes two moving averages that act as trend following indicators and creates a momentum oscillator by subtracting the longer term moving average from the shorter term moving average. This formula creates the MACD as a double indicator for both trend identification and magnitude of momentum. The MACD lines fluctuates above and below the zero line on the histogram as the moving averages come together, crossover, and separate.
How to use MACD:
Traders can wait for signal line crossovers, center line crosses, and divergences as potential trading signals. The MACD is not bounded inside set parameters so it’s not a good tool for identifying extended overbought of oversold price levels. It is a trend and momentum indicator and shows the current direction of a move.
The MACD is calculated by subtracting the 26-period Exponential Moving Average from the 12-period EMA. The answer for the calculation is the MACD line. A nine-day EMA of the MACD is called the signal line. This is the faster signal line that shows with the MACD line, and can act as a crossover trigger for buy and sell signals in the direction of the price move to capture trends or swings. Many traders may use it as a buy signal when the stock shows the signal line crossing above its MACD line and then lock in profits when the signal line crosses back below the MACD line. The MACD indicator can be used in many ways, but it is commonly used for crossovers and divergences to create signals.
The bullish signal line MACD crossover can show momentum and a possible swing higher in price that can evolve into a sustained trend. A bullish crossover can happen near a price bottom after a rally off the lows or when price emerges out of a price range. A bearish MACD signal line cross under can show the loss of momentum early when a trend turns into a range and fails to make new highs. A bearish MACD cross under can also signal the beginning of a downtrend and the end of an uptrend. The MACD works best when used with other technical indicators for confirmation. For example, if you use MACD crosses to get into a trade you could use the Relative Strength Index (RSI) to exit and lock in gains as a chart become overbought with a 70 RSI zone or oversold with a 30 RSI zone. Also, if you have a key moving average crossover signal on a chart a bullish MACD cross can confirm the trade with a confluence and give the trade greater odds of success.
The MACD can help with trading price action on a chart by showing the current directional bias along with key turning points.