Moving Average Convergence Divergence (MACD)

MA = Moving Average
Convergence = coming together
Divergence = moving apart

The MACD is a technical analysis momentum indicator that shows the difference between fast and slow exponential moving averages. The most commonly used EMAs are the 26-EMA and 12-EMA. It was developed in an attempt to show the direction and strength of a trend, resulting in more clear buy and sell signals.

It compares the two EMAs, including the short-term average (12-day EMA) and the long-term average (26-day EMA). Additionally, there is a signal line (9-day EMA) that acts as a trigger that is plotted on top of the MACD and indicates opportunities to either buy or sell. (This signal is often referred to as the EMA MACD.) This signal line has positive and negative values and it is above and below the zero line, also known as an oscillator. The zero line (oscillator) represents the area of support and resistance for the indicator and the idea is to watch for movement above or below the zero line to determine positive (upward) or negative (downward) movement. Naturally, the moving average convergence divergence indicator shows positive momentum when it is above the zero line, and conversely it shows negative momentum when it is below the zero line. When the MACD is above zero signaling upward momentum, the short-term average is above the long-term average. The opposite is true when the MACD is below zero. Additionally, traders watch for the MACD to cross its signal line. When the MACD crosses up through the signal line it indicates to traders to buy, and conversely when the MACD crosses down through the signal it indicates to traders to sell.

The moving average convergence divergence is more useful in wide-swinging trading markets. There are three popular methods for using the MACD that we will discuss below. These include using crossovers, overbought/oversold conditions, and divergences.

Crossovers
Crossovers occur when the MACD moves above or below its signal line. When the MACD rises above its signal line, a bullish crossover occurs, and conversely when the MACD falls below the signal line, a bearish crossover occurs. This bullish signal indicates that the price of the stock, or other asset, is likely to have upward momentum. On the other hand, a bearish signal indicates that it may be time to sell.

Overbought/Oversold Conditions
At times the short-term moving average will pull away dramatically from the long-term moving average or in other words the MACD will rise. When this happens it signals that the security is overbought and it will soon return to more realistic levels.

Divergence
Divergence occurs when the security price diverges from the moving average convergence divergence indicator. When this happens it signals to the trader that the current trend is coming to an end. When the MACD indicator is making new highs and the prices fail to reach new highs (long entries) a bullish divergence occurs. On the other hand, when the MACD indicator is making new lows while the prices fail to reach new lows (short entries) a bearish divergence occurs. Both the bullish and bearish divergence are the most significant when they occur at the relatively overbought/oversold levels.

Continue to learn about the different types of moving averages as well as the moving average crossover. Learning about these other types of technical analysis indicators will help you to have a better understanding of the MACD. The moving average convergence divergence indicator can also be used in conjunction with other technical analysis tools such as Japanese Candlesticks. Read about the doji candlestick chart, the bullish harami candle, and the morning star. Once you have a clear understanding of the 12 major candlestick signals, you can then move onto the secondary candlestick patterns as well. Wise investors know that by combining technical analysis tools you will have an advantage over other traders who only use one method of analysis.

Please also continue your technical analysis education and read about stochastics.