MACD (Moving Average Convergence / Divergence) is one of the most popular studies in the technical analysis. Created by Gerald Appel in the 1960s this indicator reveals the shorter-term trend changes in relegation to the longer-term trend. The MACD formula is simple:
MACD = EMA1 – EMA2
Where EMA1 is a fast moving average that reflect shorter-term trend and EMA2 is a slow moving average that reflects longer-term trend. MACD is always used in a combination with a signal line which is exponential or simple moving average applied to MACD line. The signal line is used to smooth MACD and generate signals on its crossovers with MACD.
One of the most used settings for MACD is 12 for EMA1, 26 for EMA2 and 9 for signal line. Still this setting is not always fit to trading needs of all traders; therefore, the setting could vary depending on a trader's personal trading style.
The difference between the MACD and signal line forms the Histogram which was first used in 1986 by Thomas Aspray.
In technical analysis MACD is considered as a trend following indicator and is used to generate signals as well as to confirm a trend. There are three basic ways of using this indicator.
The first way of using MACD is to look for its crossovers with zero line. Positive MACD confirms an up-trend and negative MACD confirms down-trend. Thus, when this indicator drops below zero line it could be considered as a signal to sell short and when it raises above zero line it could be considered as a signal to buy long.
The second way of using MACD is to trade it and Signal Line crossovers. This is the same as to look for MACD Histogram and zero line crossovers. The technical analysis says that when MACD crosses signal line on its way down it signals selling and when it crosses signal line on its way up it signals buying.
The third way of using MACD is to define moments of divergence between price and MACD. In particular, a buy signal could be generated when price makes new low, yet MACD stays above its previous lowest point. Controversially, a sell signal could be generated when price makes new high, yet MACD stays below its previously hit high level.
Despite the fact that MACD is one of the oldest studies in technical analysis, as many other studies it generates fake signals. Furthermore, it is recommended to use it in junction with other indicators. Since MACD is price based indicator it could be a good choice to use volume based indicators to complete a trading system that uses MACD analysis.
Author Resource:-
Find out about technical analysis of different indicators applied to the S&P 500, NASDAQ 100 and DJI to create trading systems for stocks and options trading.
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