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Moving Average Convergence Divergence (MACD): Definition          

Moving Average Convergence Divergence (MACD): Definition, Calculation, and How to Use

Moving Average Convergence Divergence (MACD): Definition, Calculation, and How to Use

The Moving Average Convergence Divergence indicator is a momentum oscillator primarily used to trade trends. The Moving Average Convergence Divergence is used to understand the momentum and its directional strength by calculating the difference between two time period intervals, which are a collection of historical time series. The Moving Average Convergence Divergence is made up of three general components, the MACD line, which is the difference between two moving averages (A moving average (MA) is a stock indicator commonly used in technical analysis.), a signal line which is a moving average of the MACD line and a histogram.

The calculation involves deducting the mid-term moving average from the short-term moving averages. The histogram in The Moving Average Convergence Divergence is a horizontal oscillator divided into two parts by a baseline or zero line. It is a visual cheat sheet that shows when the MACD line is above or below the signal line. When the Moving Average Convergence Divergence line (the faster moving average) is above the signal line, the bars in the histogram are above the zero line, which is a bullish signal. When the Moving Average Convergence Divergence line is below the signal line, the histogram bars are below the zero line, which is generally bearish.

Avoid taking any positions when the trend weakens and price fluctuates in a range between support and resistance levels, the Moving Average Convergence Divergence line will cross the signal line frequently in a back-and-forth manner. The Moving Average Convergence Divergence indicator measures the convergence and divergence of two moving averages. The mid-term moving average is subtracted from the short-term moving averages to determine the correct value. 

What is Moving Average Convergence Divergence (MACD)?

The Moving Average Convergence Divergence oscillator (MACD) is one of the simplest and most effective momentum indicators available. As its name depicts, the MACD is all about the convergence and divergence of the two moving averages. Convergence happens when the moving averages move towards each other and the Divergence happens when the moving averages move away from each other. The MACD line moves above and below the zero line, which is also known as the centerline. Zero line is an essential area where the index or stock is likely trading sideways or has no trend.

What is Moving Average Convergence Divergence (MACD)?
Moving Average Convergence Divergence (MACD): Definition, Calculation, and How to Use 13

The MACD indicator is made up of three components 

  1. The MACD line, which measures the distance between two moving averages 
  2. The signal line, which identifies changes in price momentum and acts as a trigger for buy and sell signals
  3. The histogram, which represents the difference between the MACD and the signal line

When determining the MACD, only two lines are taken for calculation, the MACD line and the signal line. The Moving Average Convergence Divergence line is created by subtracting the 26-period moving average from the 12-period moving average. The signal line is the 9-period moving average of the MACD. The Moving Average Convergence Divergence is then shown as a histogram, a graphical representation of the distance between the two lines.

The MACD goes through the signal line from below means traders will use it as a buy signal and if it goes through the signal line from above, traders will use it as a sell signal. The Moving Average Convergence Divergence indicator is so widely used because it is both easy to understand and highly reliable. The Moving Average Convergence Divergence not only determines whether a trend is up or down, but also shows strong buy and sell signals. The Moving Average Convergence Divergence indicator is popular because it provides an up-to-date representation of what is happening in the market.

The graph given above is a classical example of the Moving Average Convergence Divergence(12,26,9). It is a daily chart of Nasdaq100 Electronic Fund Transfer.  

What is MACD Divergence?

When Moving Average Convergence Divergence makes highs or lows that exceed the corresponding highs and lows on the price, it is called the divergence. A bullish divergence appears when the Moving Average Convergence Divergence creates 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. When Moving Average Convergence Divergence creates a series of two falling highs that correspond with two rising highs on the price, a bearish divergence will be formed.

What is MACD Divergence?
Moving Average Convergence Divergence (MACD): Definition, Calculation, and How to Use 14

A bearish divergence that appears during a long-term bearish trend is considered confirmation that the trend is not changing. Moving Average Convergence Divergence is when the price moves in one direction and the Moving Average Convergence Divergence moves in the opposite direction. Given below is an example of The Moving Average Convergence Divergence of the stock of The USOIL on July 22 2019. 

What are MACD Crossovers?

The Moving Average Convergence Divergence has two lines (the MACD line and the Signal line), as well as the zero line. The crossing over of these causes many crossover trends in the Moving Average Convergence Divergence this phenomena is called MACD Crossover. The Moving Average Convergence Divergence crossovers are commonly used trend indicators but are not good momentum indicators. 

What are MACD Crossovers?
Moving Average Convergence Divergence (MACD): Definition, Calculation, and How to Use 15

When the “MACD Line” moves up and crosses over the “Signal Line,” it signals a bullish crossover and when the “MACD Line” declines and move below the “Signal Line,” it signals a bearish crossover. Crossovers can endure a few days or a few weeks Depending on the power of the move. The graph given below of XMR (Monero) is an example of Moving Average Convergence Divergence singleline Crossover. 

Centerline crossover patterns are similar to signal line crossover patterns except that they involve only the Moving Average Convergence and Divergence line and its relationship to the zero/centre line.  

How does Moving Average Convergence Divergence (MACD) work in Technical Analysis?

The Moving Average Convergence Divergence is appreciated by traders worldwide for its simplicity and flexibility. The Moving Average Convergence Divergence is  used as a trend or momentum indicator and signal opportunities to enter and exit positions. The Moving Average Convergence Divergence triggers technical signals when the MACD line crosses above the signal line (to buy) or falls below it (to sell).

Moving Average Convergence Divergence (MACD) is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. The Moving Average Convergence Divergence indicator is special because it brings together momentum and trend in one indicator. This unique blend of trend and momentum is applied to daily to monthly charts. The Moving Average Convergence Divergence helps to analyze the market momentum and trends to minimize losses. 

How does Moving Average Convergence Divergence (MACD) work in Technical Analysis?
Moving Average Convergence Divergence (MACD): Definition, Calculation, and How to Use 16

Moving Average Convergence Divergence is based on two exponential moving averages of closing price with different period lengths. Moving Averages Convergence Divergence measures how close or far the two moving averages are and what is the tendency in their distance – whether they are coming close to each other  (convergence) or moving further away from one another (divergence). MACD enjoys popularity among those who perform a technical analysis of markets because it signals the strength of a trend and the turning point of a trend.

How does the length of the MACD period affect its effectiveness in Technical Analysis?

The Moving Average Convergence Divergence (MACD) indicator is a commonly used technical analysis tool that helps to analyse the relationship between two exponential moving averages (EMAs) and identifies changes in their momentum. The effectiveness of the MACD is influenced by the length of the periods used in its calculation. Shorter periods such as 12 and 26 in the Moving Average Convergence Divergence calculation will react more quickly to recent price movements and will provide more frequent signals, but these signals are less reliable.

Longer periods like  50 or 200 in the MACD calculation will produce a smoother line that captures longer-term trends, but will be slower to react to changes in the market. Shorter periods will be more suitable for shorter-term traders who want to capture smaller price movements, while longer periods will be more suited for longer-term traders who want to capture bigger trends. Longer periods produces fewer signals, but they will be more reliable and have fewer false signals compared to shorter periods.

What is the purpose of MACD?

The Moving Average Convergence Divergence is a trend-following momentum indicator that measures the relationship between two moving averages of a security’s price. The investors use the Moving Average Convergence Divergence to identify when bullish or bearish momentum of a stock  is high to identify entry and exit points for trades.

The ultimate purpose of the Moving Average Convergence Divergence is to provide insights into the momentum and direction of a particular asset’s price movement. The Moving Average Convergence Divergence iss a straightforward indicator that is easy to understand and implement in technical analysis. The versatile nature of the Moving Average Convergence Divergence can help the indicator to be used across different timeframes and for various financial instruments, including stocks, commodities, currencies, and cryptocurrencies. 

How to calculate MACD?

The Moving Average Convergence Divergence is calculated by subtracting the 26-period (7.5%)  Exponential Moving Average from the 12-period (15%) moving average. Here are step-by-step instructions for calculating the Moving Average Convergence Divergence (MACD) indicator.

1. First, calculate the 26-period exponential moving average (EMA) of the closing price. 

2. Next, calculate the 12-period EMA of the closing price.

3. Then, subtract the 12-period EMA from the 26-period EMA to obtain the MACD line. This represents the difference between the short-term and long-term moving averages.

4. After that, calculate the 9-period EMA of the MACD line itself. This yields the Signal line.

5. Finally, subtract the Signal line from the MACD line to generate the MACD histogram. The histogram shows the difference between the MACD line and its Signal line.

6. If the MACD line is above the Signal line, the histogram will be positive. If the MACD line is below the Signal line, the histogram will be negative.

7. The crossover of the MACD line and Signal line can provide trade signals. A crossover below the zero line can indicate a downtrend, while a crossover above can signal an uptrend.

Compute the longer and shorter EMAs, subtract to get the MACD line, take the EMA of that MACD line to get the Signal line, then take the difference between the MACD and Signal lines to get the MACD histogram. This shows momentum.

What does MACD 12, 26, 9 mean?

The 12 from the Moving Average Convergence Divergence represents a moving average of the previous 12 bars. The 26 represents a moving average of the previous 26 bars. The 9 represents a moving average of the difference between the two moving averages 12 and 26 above. The 12 and 26 day EMAs are used to construct the MACD lines. MACD is calculated as the difference between the values of these two EMAs.

A signal line is the 9 day EMA of the MACD. MACD = EMA (Price, 12 period) – EMA (Price, 26 period). The 12-period Exponential Moving Average represents the shorter-term trend, the 26-period Exponential Moving Average represents the longer-term trend, and the 9-period EMA represents the signal line. The 12, 26, and 9 values for MACD’s arguments are the most commonly used, but traders can adjust these values based on their preferences and trading strategies.

How to use MACD in Trading?

The Moving Average Convergence Divergence (MACD) is a popular technical analysis indicator which is used in  trading to identify potential buy and sell signals. Below is the step to calculate the same.

  • Calculate the 12-period EMA and 26-period EMA of the closing price.
  • Subtract the 26-period EMA from the 12-period EMA to get the MACD line.
  • Calculate the 9-period EMA of the MACD line to get the Signal line.
  • Plot the MACD line and Signal line on a price chart.
  • When the MACD line crosses above the Signal line, it’s a bullish crossover indicating a potential buy signal.
  • When the MACD line crosses below the Signal line, it’s a bearish crossover indicating a potential sell signal.
  • The MACD histogram represents the difference between the MACD line and the Signal line.
  • Positive MACD histogram signals upside momentum, while negative MACD histogram signals downside momentum
  • Analyze the MACD line, Signal line, and histogram together to generate trading signals and understand price momentum.

What are different ways to use MACD to identify potential buy and sell signals?

The Moving Average Convergence Divergence (MACD) is a popular technical analysis indicator used in trading to identify potential buy and sell signals. Below are four different ways to use it.

  1. Signal Line Crossovers

 It generates a bullish signal indicating a potential buy opportunity when the MACD line crosses above the signal line also it generates a bearish signal indicating a potential sell opportunity when the MACD line crosses below the signal line. Investors wait for the crossover to occur and then enter a trade in the direction of the crossover.

  1. Centerline Crossovers

It generates a bullish signal indicating a potential buy opportunity when the MACD line crosses above the centerline (zero line) from below similarly it generates a bearish signal indicating a potential sell opportunity when the MACD line crosses below the centerline from above. The centerline Crossovers method focuses on the MACD line’s position relative to the centerline to determine the trading bias.

  1. Divergence

It suggests a potential bullish reversal and a possible buy signal when the price makes a lower low, but the MACD indicator makes a higher low and It suggests a potential bearish reversal and a possible sell signal when the price makes a higher high, but the MACD indicator makes a lower high. Divergences provide early signals of a potential trend reversal. 

  1. Zero Line Rejection

It indicates a potential buy signal as it suggests a rejection of the bearish momentum when the MACD line briefly dips below the zero line and then quickly bounces back above it and it indicates a potential sell signal as it suggests a rejection of the bullish momentum when the MACD line briefly moves above the zero line and then quickly falls back below it.

Combine Moving Average Convergence Divergence signals with other technical analysis tools and indicators to confirm potential buy and sell signals before making trading decisions. Also consider factors such as market sentiments, market conditions, trend analysis, and risk management strategies to enhance your trading approach.

How do traders use the MACD histogram to identify trends?

Investors use the Moving Average Convergence Divergence (MACD) histogram as a tool to identify trends and potential trading opportunities in financial markets The histogram’s bars plotted from the Moving Average Convergence Divergence provide visual cues about the strength and direction of the trend. 

  1. Positive Histogram

It indicates that the MACD line is above the signal line when the histogram bars are above the zero line, suggesting bullish momentum. Higher the bar in the histogram stronger the trend is. 

  1. Negative Histogram

It indicates that the MACD line is below the signal line when the histogram bars are below the zero line, suggesting bearish momentum. Similar to positive bars, the height of the negative bars represents the strength of the trend. 

  1. Zero Line Crossover

When the histogram crosses above the zero line, it suggests a potential bullish trend reversal, indicating a shift from bearish to bullish momentum similarly when the histogram crosses below the zero line, it suggests a potential bearish trend reversal.

  1. Divergence

Investors also observe for divergences between the price chart and the MACD histogram. When the price is making higher highs while the MACD histogram is making lower highs, it indicates weakening trend or trend reversal

  1. Convergence

When the histogram bars are narrowing and approaching the zero line, it indicates a potential convergence, this suggests a potential trend reversal

Moving Average Convergence Divergence is an important tool  among many used by traders to identify trends. Traders often combine it with other technical indicators, such as moving averages, support and resistance levels, and volume analysis to get better results or predictions of the market.

How does MACD perform in a Bullish Market?

When the Moving Average Convergence Divergence line crosses from below to above the signal line, the indicator is considered bullish. The further below the zero line the stronger the signal for the trend of  a bullish market. In a bullish market, where prices are rising, the Moving Average Convergence Divergence can provide traders with useful signals and predictions. when the MACD line crosses above the signal line.

In a bullish market, this bullish crossover can indicate a potential buying opportunity known as the Bullish Signal Line Crossovers. In a bullish market, the MACD histogram is generally above the zero line and consists of positive bars. The height and width of the positive bars can provide information about the strength of the upward momentum. The MACD line remains above the signal line and the histogram consistently shows positive bars, it indicates that the bullish momentum is intact. Divergences can still occur and provide valuable insights. Traders should pay attention to any potential bearish divergences between the price chart and the MACD histogram.

How does MACD perform in a Bearish Market?

When the Moving Average Convergence Divergence line crosses from above to below the signal line, the indicator is considered bearish. The further above the zero line the stronger the signal for the trend of a Bearish Market. In a bearish market, where prices are generally declining, the MACD can provide traders with useful signals and predictions. One of the primary signals generated by the MACD is when the MACD line crosses below the signal line.

In a bearish market, this bearish crossover can indicate a potential selling opportunity, this is known as the  Bearish Signal Line Crossovers. The MACD histogram is generally below the zero line and consists of negative bars this indicate a Bearish Market. The height and width of the negative bars can provide information about the strength of the downward momentum. Larger the bar the stronger the trend is. The MACD line remains below the signal line and the histogram consistently shows negative bars, it indicates that the bearish momentum is intact. Divergences can still occur traders should pay attention to any potential bullish divergences between the price chart and the MACD histogram.

What is the best trading strategy for MACD?

The best trading strategy for Moving Average Convergence Divergence can vary depending on individual preferences, trading style, sentiment of the traders and the specific market conditions. 

The simplest Moving Average Convergence Divergence strategy does not require any additional supplements. Moving Average Convergence Divergence signals alone will be sufficient enough. If the Moving Average Convergence Divergence histogram crosses the moving average upwards, place the buy order and If the Moving Average Convergence Divergence histogram crosses the moving average downwards, place the sell order. 

When the Moving Average Convergence Divergence crosses from below the zero line, it is considered a bullish signal, take a long position when this occurs. If it  crosses from above the zero line, it is considered a bearish signal by traders, take a short position when this occurs and take advantage of falling prices and increasing downward momentum. 

Money Flow Index oscillator is the money flow index, which focuses on both price and volume. The money flow index requires both price movement and volume spikes to create extreme readings.This approach will combine the MACD stock indicator’s crossing with the money flow index’s overbought/oversold signals.

When to use Moving Average Convergence Divergence (MACD)?

The MACD is most useful when there is a trend underway that you want to trade in the direction of. When prices are trending higher, watch for the MACD line to crossover above the signal line and turn positive. This suggests upside momentum is building and provides a buy signal to trade the uptrend. Conversely, when prices are in a downtrend, a crossover below the signal line and MACD turning negative hints downside momentum is accelerating.

This crossover can trigger a sell signal. Additionally, the widening or narrowing of the MACD histogram provides clues on momentum. If upside momentum is increasing, the histogram will expand. When downside momentum slows, histogram bars shrink. So MACD helps identify and confirm the dominant trend direction and time entries based on momentum. During range-bound non-trending markets, MACD has less value and may whipsaw on false signals. MACD is best applied when trading with the momentum of established trends.

How can MACD be utilised with other Indicators to improve trading performance?

One effective approach is to combine MACD with trend-following indicators like moving averages to trade in the direction of the overall trend. For example, traders may look to only take MACD buy signals if the price is above the 50-day moving average, showing an established uptrend. Using the indicators together provides assurance of trading with the prevailing trend.

Oscillators like the RSI can also help confirm overbought or oversold conditions. If the RSI is above 70, traders may wait for it to drop before acting on a MACD buy signal. This helps avoid buying right at exhausted highs.

Additionally, watch for MACD and Bollinger Band squeeze set-ups, when the MACD histogram contracts as Bollinger Bands tighten. These conditions often precede sharp volatility expansion. Combining the indicators provides advanced warning.

What are the advantages of MACD?

]The Moving Average Convergence Divergence (MACD) indicator is widely used by traders due to its versatility and effectiveness in signaling momentum and trend changes. Here are 6 key advantages of using the MACD.

1. Identifies Trend Changes. MACD crossovers alert traders to changes from bullish to bearish market momentum and back again. This helps identify trend reversals early.

2. Confirms Price Action. MACD divergence from price action can confirm or contradict signals from candlestick patterns or support/resistance. The combination validates signals. 

3. Gauges Momentum. The widening and narrowing MACD histogram reflects strengthening and weakening upside/downside momentum respectively. This shows acceleration or exhaustion.

4. Simple to Use. The MACD principles are easy to understand compared to more complex indicators. Traders can quickly interpret signals.

5. Versatile Time Frames. MACD works on charts ranging from 1 minute to weekly time frames. Intraday scalpers to long-term investors can apply it.

6. Works Across Assets. MACD can be used to analyze momentum in forex, stocks, commodities, and cryptocurrencies, making it widely applicable.

With its straightforward setup, intuitive signals, and flexibility across assets and time frames, MACD is one of the most popular and useful indicators for traders in technical analysis.

What are the disadvantages of MACD?

While the Moving Average Convergence Divergence indicator is widely used and has proven to be very helpful in technical analysis, it also has certain disadvantages. Here are five drawbacks to consider

1. Lagging Indicator. The MACD is based on moving averages, which are lagging indicators. Signals occur after the start of a trend, missing early entries.

2. False Signals. MACD can give false signals in choppy or ranging markets, leading to losing trades if acted on prematurely. More confirmation may be needed.

3. Overbought/Oversold Levels. MACD does not identify overbought or oversold levels in a range like RSI or Stochastics. Other indicators are needed for this. 

4. Signal Line Crossovers. The MACD line and signal line will inevitably cross back and forth multiple times, making timing entries difficult. Not every crossover results in a sustained trend.

5. Subjective Interpretation. Settings like the MACD periods can be tweaked, affecting signals. Traders may interpret MACD histograms or crossovers differently. Confirmation reduces subjectivity.

While MACD is a very useful indicator, traders should be aware of these disadvantages. Using MACD together with other indicators helps overcome some limitations and improves analysis.

Does a crossover between the MACD line and signal line indicate a potential buy or sell signal?

Yes, crossovers between the MACD line and signal line can act as trade signals. When the MACD line crosses above the signal line, it indicates upside momentum is accelerating and may prompt entering a long position. Conversely, when the MACD line crosses below the signal line, it suggests downside momentum is accelerating and could trigger exiting a long or entering a short position.

Is the MACD indicator more effective in trending markets than in ranging markets?

Yes, The Moving Average Convergence Divergence indicator is generally considered more effective in trending markets compared to ranging markets. In trending markets, where prices are consistently moving in an uptrend or downtrend, the MACD can provide proper signals. In an uptrend, the MACD line stay above the signal line, signaling bullish momentum. 

Can MACD be used to predict market trends?

Yes, MACD is useful for identifying shifts in momentum and trend direction. However, like other indicators, it is not meant to predict future price levels or trends by itself. It is more useful when combined with other analysis.

Is MACD based on Moving Averages?

Yes, MACD is based on moving averages. It subtracts the 26-period exponential moving average (EMA) from the 12-period EMA to create the MACD line. A 9-period EMA of the MACD line forms the signal line.

What is the difference between MACD and RSI?

MACD and RSI are both momentum indicators but have different ways of measuring and identifying momentum. They provide different information that can be complementary in analysis. MACD is a trend-following indicator while RSI is a momentum oscillator indicator.

MACD uses moving averages and convergences/divergences to identify shifts in momentum. RSI uses a single line bounded by upper and lower levels.

MACD plots the relationship between two EMAs. RSI plots the current price relative to recent price highs and lows. MACD is better for identifying trend direction while RSI helps determine overbought/oversold levels. Traders often use them together for analysis.

What is the difference between MACD and Moving Averages?

The Moving Average Convergence Divergence and Moving Averages are both technical analysis tools used to analyse price trends, but they differ in purposes and calculations.The four key differences are listed below.

  1. Purpose: The Moving Average Convergence Divergence focuses on the relationship between two moving averages and their convergence or divergence. Meanwhile Moving Averages are used to smooth out price data and identify the average price over a specific period.
  1. Calculation: The MACD is calculated by subtracting the longer-term exponential moving average (EMA) from the shorter-term EMA. Moving averages are calculated by taking the average of the closing prices over a specific period.
  1. Focus: The Moving Averages focuses on the convergence and divergence of two moving averages, highlighting changes in momentum and potential trend reversals. Moving averages provide a smoothed line that helps identify the direction and strength of a trend.
  1. Interpretation: Crossovers and divergences between the MACD line and the signal line are often used as buy or sell signals. In moving averages traders look for the interaction between price and moving averages. When price crosses above a moving average, it can signal a potential uptrend, while a cross below a moving average suggest a potential downtrend

Both the MACD and Moving Averages are tools for analyzing trends, the MACD specifically focuses on the relationship between two moving averages. Moving averages, on the other hand, provide a smoothed line to identify the direction and strength of the trend and generate correct Signals regarding trend Reversal. 

Arjun
Arjun Remesh

Head of Content

Arjun is a seasoned stock market content expert with over 7 years of experience in stock market, technical & fundamental analysis. Since 2020, he has been a key contributor to Strike platform. Arjun is an active stock market investor with his in-depth stock market analysis knowledge. Arjun is also an certified stock market researcher from Indiacharts, mentored by Rohit Srivastava.

Shivam
Shivam Gaba

Reviewer of Content

Shivam is a stock market content expert with CFTe certification. He is been trading from last 8 years in indian stock market. He has a vast knowledge in technical analysis, financial market education, product management, risk assessment, derivatives trading & market Research. He won Zerodha 60-Day Challenge thrice in a row. He is being mentored by Rohit Srivastava, Indiacharts.

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