As previously touched on in lesson n. 12, MACD is an acronym for Moving Average Convergence Divergence. It is a “momentum” indicator that “follows trends” and shows the relationship between two moving average prices. MACD is calculated by subtracting an exponential moving average (EMA) at 26 days from the 12-day exponential moving average (EMA). Another 9-day EMA is used as a reference and is called the “signal line”. This is located above the MACD, and offers buy or sell signals. Those who want to can review the lesson on moving averages.
Confused? Let’s recap:
- EMA = Exponential Moving Average (you will not have to calculate it, you’ll find it already drawn on the chart!)
- MACD = EMA 26 days – EMA 12 days
- Signal line = a line that advises what to do = 9-day EMA
Here is an example of a chart with MACD. The MACD is in green, the signal in blue.
How to use MACD?
MACD in trading can be used in three different ways depending on how the market is interpreted:
When the MACD falls below the signal line (9-day EMA), this method interprets it as a downward signal, and advises one to sell. On the contrary, when the MACD rises above the signal line, the indicator must be interpreted in a bullish way (see figure), starting from the moment it crosses below zero.
Many traders are waiting for a confirmation crossing over the signal line before opening a position, in order to avoid being penalized by entering a position too early.
By divergence we mean the moment when the price diverges from the MACD. This is the signal of the end of the current trend.
c) Sudden rise
When the MACD has a very strong upside (the shorter moving average jumps from the longer-term) the signal is over-bought and therefore will soon return to normal levels.
Traders also watch the movements above and below the zero line with interest, as this signals the position of the short-term average in relation to the long-term one. When the MACD is above zero, the short-term average is higher than the long-term average. In contrast, when the MACD is below zero, the short-term average is lower than the long-term average.
The zero line often acts as a support and resistance zone for the indicator.
Go to lesson 20 – Momentum Oscillator