What is the MACD
MACD (Moving Average Convergence/Divergence)
The MACD, developed by Gerald Appel in the late 1970s, is a technical analysis indicator used to
identify changes in the strength, direction, momentum, and duration of a trend in a trading
instrument’s price. It calculates the difference between two exponential moving averages (EMAs) of
closing prices and charts this difference over time, alongside a moving average of the difference. This
divergence is shown as a histogram or bar graph.
Basic Components:
- MACD Line (Blue): Difference between the 12-day and 26-day EMAs.
- Signal Line (Red): 9-day EMA of the MACD line.
- Histogram: Difference between the MACD line and the Signal line.
The standard parameters for the MACD are 12, 26, and 9, written as MACD (12,26,9).
Interpretation: The MACD highlights recent changes in price by comparing EMAs of different lengths
to gauge trend changes. Analysts use three key signals:
- Signal Line Crossover: Buy when the MACD line crosses above the Signal line (bullish
crossover) and sell when it crosses below (bearish crossover). The histogram helps visualize
these crossovers. - Zero Crossover: The MACD line crossing zero indicates a trend change—positive to negative
is bearish, and negative to positive is bullish. - Divergence: Discrepancies between the MACD line and stock price. Positive divergence (price
hits a new low, but MACD doesn’t) is bullish, while negative divergence (price hits a new high,
but MACD doesn’t) is bearish.
Timing and Context: The MACD’s usefulness depends on context. Analysts might use different time
scales (e.g., weekly then daily) to avoid short-term trades against the intermediate trend. Adjusting
the MACD’s parameters can help track trends of varying durations, such as using a (5,35,5) setup for
short-term analysis.
False Signals and Limitations: The MACD can generate false signals, like a bullish crossover followed
by a price drop (false positive) or a missed bullish crossover before a price rise (false negative).
Applying filters, like requiring the MACD to stay above the Signal line for three days, can reduce false
signals. The MACD, being a lagging indicator, is often paired with leading indicators like the RSI.
The MACD is less effective in non-trending or erratic markets, where it fails to provide meaningful
feedback due to rapid or countervailing price changes. Adjusting the MACD for different timeframes
can partially address this issue.
Finally, while some trade solely on technical indicators, many recommend a comprehensive analysis
of a company’s fundamentals to complement the MACD, ensuring sound trading decisions.