What is MACD And How to Use MACD in Trading
What Is Moving Average Convergence Divergence (MACD)?
MACD(Moving Average Convergence Divergence) is a trend-following indicator that shows the relationship between two moving averages of an asset's price. Moving Average Convergence Divergence is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. The result of that calculation is the MACD line. A nine-day EMA of the Moving Average Convergence Divergence called the "Signal Line" is plotted on top of the line, which can function as a trigger for buy and sell signals.
MACD is often displayed with a Histogram (see the chart below) which graphs the distance between the MACD and its signal line. If the MACD is above the signal line, the histogram will be above the MACD’s baseline. If the Moving Average Convergence Divergence is below its signal line, the histogram will be below the MACD’s baseline. Traders use the MACD’s histogram to identify whether bullish or bearish momentum is high.
How to trade with MACD
Traders may buy the security when the Moving Average Convergence Divergence crosses above its signal line and sell - or short - the security when the MACD crosses below the signal line. MACD indicators can be interpreted in commonly three methods: Crossovers, Divergences, and Rapid Rises/falls.
1. MACD Crossovers
As shown on the following chart, 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.
Some traders wait for a confirmed cross above the signal line before entering a position to reduce the chances of being "faked out" and entering a position too early.
Crossovers are more reliable when they conform to the prevailing trend. If the MACD crosses above its signal line following a brief correction within a longer-term uptrend, it qualifies as bullish confirmation.
If the MACD crosses below its signal line following a brief move higher within a longer-term downtrend, traders would consider that a bearish confirmation.
2. MACD Divergence
When the MACD forms highs or lows that diverge from the corresponding highs and lows on the price, it is called a divergence. A bullish divergence appears when the MACD forms two rising lows that correspond with two falling lows on the price. This is a valid bullish signal when the long-term trend is still positive. Some traders will look for bullish divergences even when the long-term trend is negative because they can signal a change in the trend, although this technique is less reliable.
3. Rapid Rises or Falls
When the Moving Average Convergence Divergence rises or falls rapidly (the shorter-term moving average pulls away from the longer-term moving average), it is a signal that the security is overbought or oversold and will soon return to normal levels. Traders will often combine this analysis with the Relative Strength Index (RSI) or other technical indicators to verify overbought or oversold conditions.
It is not uncommon for investors to use the MACD’s histogram the same way they may use the MACD itself. Positive or negative crossovers, divergences, and rapid rises or falls can be identified on the histogram as well. Some experience is needed before deciding which is best in any given situation because there are timing differences between signals on the Moving Average Convergence Divergence and its histogram.
- Moving Average Convergence Divergence is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA.
- Moving Average Convergence Divergence triggers technical signals when it crosses above (to buy) or below (to sell) its Signal Line.
- Traders use the MACD’s Histogram to identify whether bullish or bearish momentum is high.
- The speed of crossovers is also taken as a signal of a market is overbought or oversold.
- Moving Average Convergence Divergence helps investors understand whether the bullish or bearish movement in the price is strengthening or weakening.