Moving Average Convergence Divergence (MACD)
What Is Moving Average Convergence Divergence (MACD)?
Moving average convergence divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security's price. The MACD is calculated by taking away the 26-period exponential moving average (EMA) from the 12-period EMA.
The aftereffect of that calculation is the MACD line. A nine-day EMA of the MACD called the "signal line," is then plotted on top of the MACD line, which can function as a trigger for buy and sell signals. Traders may buy the security when the MACD crosses over its signal line and sell — or short — the security when the MACD crosses below the signal line. Moving average convergence divergence (MACD) indicators can be deciphered in more ways than one, however the more normal methods are crossovers, divergences, and quick ascents/falls.
MACD Formula
MACD is calculated by deducting the long-term EMA (26 periods) from the short-term EMA (12 periods). An exponential moving average (EMA) is a type of moving average (MA) that puts a greater weight and significance on the latest data points.
The exponential moving average is likewise referred to as the exponentially weighted moving average. An exponentially weighted moving average responds more fundamentally to recent price changes than a simple moving average (SMA), which applies an equivalent weight to all perceptions in the period.
Learning From MACD
The MACD has a positive value (displayed as the blue line in the lower chart) at whatever point the 12-period EMA (indicated by the red line on the price chart) is over the 26-period EMA (the blue line in the price chart) and a negative value when the 12-period EMA is below the 26-period EMA. The more far off the MACD is above or below its baseline demonstrates that the distance between the two EMAs is developing.
In the following chart, you can perceive how the two EMAs applied to the price chart relate to the MACD (blue) crossing above or below its baseline (ran) in the indicator below the price chart.
MACD is frequently shown with a histogram (see the chart below) which diagrams the distance between the MACD and its signal line. Assuming the MACD is over the signal line, the histogram will be over the MACD's baseline. On the off chance that the MACD is below its signal line, the histogram will be below the MACD's baseline. Traders utilize the MACD's histogram to distinguish when bullish or bearish momentum is high.
MACD versus Relative Strength
The relative strength indicator (RSI) plans to signal whether a market is considered to be overbought or oversold corresponding to recent price levels. The RSI is an oscillator that computes average price gains and losses over a given period of time. The default time span is 14 periods with values limited from 0 to 100.
MACD measures the relationship between two EMAs, while the RSI measures price change according to recent price highs and lows. These two indicators are frequently utilized together to give analysts a more complete technical image of a market.
These indicators both measure momentum in a market, but, since they measure various factors, they once in a while give opposite indications. For instance, the RSI may show a perusing over 70 for a supported period of time, demonstrating a market is overstretched to the buy-side comparable to recent prices, while the MACD shows the market is as yet expanding in buying momentum. Either indicator may signal an impending trend change by showing divergence from price (price proceeds higher while the indicator turns lower, or vice versa).
Limitations of MACD
One of the main problems with divergence is that it can frequently signal a potential reversal however at that point no genuine reversal really occurs — it creates a false positive. The other problem is that divergence doesn't forecast all reversals. At the end of the day, it predicts too many reversals that don't happen and insufficient real price reversals.
"False positive" divergence frequently happens when the price of an asset moves sideways, for example, in a range or triangle pattern following a trend. A slowdown in the momentum — sideways movement or slow trending movement — of the price will make the MACD pull away from its prior limits and incline toward the zero lines even without any a true reversal.
Illustration of MACD Crossovers
As displayed on the following chart, when the MACD falls below the signal line, a bearish signal demonstrates that it very well might be an ideal opportunity to sell. On the other hand, when the MACD transcends the signal line, the indicator gives a bullish signal, which proposes that the price of the asset is probably going to experience up momentum. A few traders sit tight for a confirmed cross over the signal line before entering a position to reduce the possibilities being "faked out" and entering a position too early.
Crossovers are more dependable when they adjust to the overarching trend. In the event that the MACD crosses over its signal line following a short correction inside a longer-term uptrend, it qualifies as bullish confirmation.
On the off chance that the MACD crosses below its signal line following a concise move higher inside a longer-term downtrend, traders would consider that a bearish confirmation.
Illustration of Divergence
At the point when the MACD forms highs or lows that veer from the relating highs and lows on the price, it is called a divergence. A bullish divergence seems when the MACD forms two rising lows that relate with two falling lows on the price. This is a legitimate bullish signal when the long-term trend is as yet positive.
A few traders will search for bullish divergences even when the long-term trend is negative since they can signal a change in the trend, albeit this technique is less dependable.
At the point when the MACD forms a series of two falling highs that compare with two rising highs on the price, a bearish divergence has been shaped. A bearish divergence that shows up during a long-term bearish trend is considered confirmation that the trend is probably going to proceed.
A few traders will look for bearish divergences during long-term bullish trends since they can signal weakness in the trend. In any case, it isn't quite as solid as a bearish divergence during a bearish trend.
Illustration of Rapid Rises or Falls
At the point when the MACD rises or falls quickly (the shorter-term moving average pulls from the longer-term moving average), it is a signal that the security is overbought or oversold and will before long return to normal levels. Traders will frequently join this analysis with the relative strength index (RSI) or other technical indicators to check overbought or oversold conditions.
It isn't uncommon for investors to utilize the MACD's histogram the same way they may utilize the MACD itself. Positive or negative crossovers, divergences, and fast ascents or falls can be distinguished on the histogram also. Some experience is required before concluding which is best in some random situation since there are timing differences between signals on the MACD and its histogram.
Highlights
- MACD triggers technical signals when it crosses above (to buy) or below (to sell) its signal line.
- The speed of crossovers is likewise taken as a signal of a market is overbought or oversold.
- MACD assists investors with understanding whether the bullish or bearish movement in the price is strengthening or debilitating.
- Moving average convergence divergence (MACD) is calculated by deducting the 26-period exponential moving average (EMA) from the 12-period EMA.
FAQ
How Do Traders Use Moving Average Convergence Divergence (MACD)?
Traders use MACD to distinguish changes toward the path or seriousness of a stock's price trend. MACD can appear to be muddled from the get go, since it depends on extra statistical concepts like the exponential moving average (EMA). In any case, fundamentally, MACD assists traders with identifying when the recent momentum in a stock's price may signal a change in its underlying trend. This can assist traders with choosing when to enter, add to, or exit a position.
Is MACD a Leading Indicator, or a Lagging Indicator?
MACD is a lagging indicator. All things considered, the data utilized in MACD is all in light of the historical price action of the stock. Since it depends on historical data, it must essentially "slack" the price. Be that as it may, a few traders use MACD histograms to predict when a change in trend will happen. For these traders, this part of the MACD may be seen as a leading indicator of future trend changes.
What Is a MACD Positive Divergence?
A MACD positive divergence is a situation wherein the MACD doesn't arrive at a new low, regardless of the way that the price of the stock arrived at a new low. This is viewed as a bullish trading signal — consequently, the term "positive divergence." If the contrary scenario happens — the stock price coming to another high, however the MACD neglecting to do so — this would be viewed as a bearish indicator and referred to as a negative divergence.
