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MACD, Moving Average Convergence/Divergence

Introduction to Moving Average Convergence/Divergence

MACD, which stands for Moving Average Convergence/Divergence, is a technical analysis indicator. MACD lines are often regarded as a trend following indicator designed to identify trend changes. The MACD histogram as drawn below is sometimes used as an oscillator. Three types of trading signals are generated:· In the FIgure below, Priceline stock has Crossover happens around $55 indicating a buy signal ·(indicatd by the Green Triangle on the leftin the Figure below). The signal line crossing is the usual trading rule. 
  
 

The standard interpretation is to buy. The histogram shows  when a crossing occurs. When the MACD line crosses through zero on the histogram it is said that the MACD line has crossed the signal line. The histogram can also help visualizing when the two lines are coming together. Both may still be rising, but coming together, so a falling histogram suggests a crossover may be approaching.when the MACD crosses up through the signal line, or sell when it crosses down through the signal line.

Priceline MACD

 

These crossings may occur too frequently, and other tests may have to be applied. In the diagram above you can see that the MACD moving averages cross over each other where the orange line is located in the figure above. This indicates that a buy signal is happening because the 12 period EMA crosses over the slower moving 26-period EMA, which causes MACD to cross below the zero line.

A crossing of the MACD line up through zero is interpreted as bullish, or down through zero as bearish. These crossings are of course simply the original EMA(12) line crossing up or down through the slower EMA(26) line.Positive divergence between MACD and price arises when price makes a new selloff low, but the MACD doesn't make a new low (i.e. it remains above where it fell to on that previous price low). This is interpreted as bullish, suggesting the downtrend may be nearly over. Negative divergence is the same thing when rising (i.e. price makes a new rally high, but MACD doesn't rise as high as before), this is interpreted as bearish.Divergence may be similarly interpreted on the price versus the histogram, where the new price levels are not confirmed by new histogram levels. Longer and sharper divergences (distinct peaks or troughs) are regarded as more significant than small shallow patterns in this case.It is recommended to look at a MACD on a weekly scale before looking at a daily scale to avoid making short term trades against the direction of the intermediate trend. Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day.··


Another Example of MACD

Below you can see the MACD, using a weekly chart for Apple. Look at the green triangle, just beneath the up pointing red arrows, and notice that the MACD, Moving Average Convergence/Divergence for this stock indicates a buying opportunity.

Apple MACD Chart


To summarize the details of the Moving Average Convergence Divergence – MACD:

There are·three common methods used to interpret the MACD:

1. Crossovers - As shown in the chart above, 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·getting "faked out" or entering ·into a position too early,·as shown by the first arrow.·

2. Divergence - When the security 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 security 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.


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