MACD is an important indicator used in technical analysis. The Moving Average Convergence Divergence or MACD as it is commonly referred to is an oscillator which highlights the strength of the trend and likely reversal thereof. It uses moving averages as inputs to derive the oscillator values. Basically the indicator converts three moving averages into two. The moving average used is exponential moving average to make the oscillator more sensitive to the latest price movement.
MACD is the difference between a fast and slow exponential moving average. Usually, the 12 and 26 days EMAs are used to construct the MACD lines. MACD is the computed as the difference between the values of these two EMAs. A signal line is the 9 day EMA of the MACD.
Constructing and Formulating MACD
The MACD line is the difference between a 12 period EMA (exponential moving average) and a 26 period EMA. The signal line is the 9 period EMA of the MACD.The difference between MACD and the signal line is computed and plotted as a bar histogram. This is also known as a MACD histogram. Advanced softwares calculate all these values and hence the calculation part is now a day’s only theoretical in nature.
MACD = EMA (Price, 12 period) – EMA (Price, 26 period)
Signal line = EMA (MACD, 9 period)
Histogram plot = MACD Line – Signal Line
In the NIFTY Index chart above, the MACD indicators have been exhibited in the bottom panel.
The Black line is the MACD Line and the Red Line in the image above is the Signal line. The bars as visible in green and blue are the MACD histogram. The Green Bar stands for an increasing bar and the blue bar stands for a decreasing bar.
How to use and interpret MACD?
Spotting divergences is one of the most common and effective patterns in technical analysis. Patterns where the MACD shows divergence from prices can be an important signal although the pattern needs time to develop and should not be anticipated. Combining MACD line crossovers with other technical patterns can make the MACD system more reliable as a systems trading.
How to read the signal?
One of the most common signals in technical analysis is the MACD line crossing over the signal line. A buy signal is generated when MACD crosses above the signal line, whereas a sell signal is generated when it crosses below the signal line. Since the histogram is nothing but the difference between the MACD line and the signal line, it helps in identifying this crossover. Buy and Sell signals are also generated by divergences. A divergence is when the price and indicator move in opposite directions. A positive divergence arises when the stock makes a low or moves sideways, but the MACD moves upward. Similarly a negative divergence is created when a stock makes a new high and the MACD moves downward.
These intersections are known as MACD crossovers.
Conclusion: Technical Analysis Indicators are very powerful but they have to be used in the proper context without which the utility of the indicator diminishes. During trading or investing it is essential to keep the many things in mind, indicators like MACD are important in the arsenal of the traders and investors but they have to to be used in conjunction with other confirming tools and patterns.