The moving average convergence-divergence indicator (MACD) is supposed to reveal changes in the strength, direction, momentum, and duration of a trend in a market’s price.
Calculation
MACD Line: (12-day EMA – 26-day EMA)
Signal Line: 9-day EMA of MACD Line
MACD Histogram: MACD Line – Signal Line
The MACD Line is the 12-day Exponential Moving Average (EMA) less the 26-day EMA. Closing prices are used for these moving averages. A 9-day EMA of the MACD Line is plotted with the indicator to act as a signal line and identify turns. The MACD Histogram represents the difference between MACD and its 9-day EMA, the Signal line. The histogram is positive when the MACD Line is above its Signal line and negative when the MACD Line is below its Signal line.The values of 12, 26 and 9 are the typical setting used with the MACD, however other values can be substituted depending on your trading style and goals.
There are three common methods used to interpret the MACD:
1. Crossovers – when the MACD falls below the signal line, it is a bearish signal, which indicates that it may be time to sell. Conversely, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Many traders wait for a confirmed cross above the signal line before entering into a position to avoid getting “faked out” or entering into a position too early.
2. Divergence – When the price diverges from the MACD. It signals the end of the current trend.
3. Dramatic rise – When the MACD rises dramatically – that is, the shorter moving average pulls away from the longer-term moving average – it is a signal that the price is overbought and will soon return to normal levels.
Traders also watch for a move above or below the zero line because this signals the position of the short-term average relative to the long-term average. When the MACD is above zero, the short-term average is above the long-term average, which signals upward momentum. The opposite is true when the MACD is below zero.
