What is Moving Average Convergence/Divergence(MACD) and how do I use it?

The connection between two exponential moving averages (EMAs) of the price of a security is displayed by the trend-following momentum indicator known as moving average convergence/divergence (MACD, or MAC-D). The 26-period EMA is subtracted from the 12-period EMA to calculate the MACD line.

The MACD line is the output of the computation. The signal line, which is then drawn on top of the MACD line and may be used as a trigger for buy or sell signals, is a nine-day EMA of the MACD line. When the MACD line crosses above the signal line, traders may purchase the asset; when it crosses below, they may sell—or short—the security. There are various ways to interpret MACD indicators, however, the most popular ones include crosses, divergences, and rapid rises/falls.

MACD Formula

MACD=12-Period EMA − 26-Period EMA

The MACD is derived by deducting the long-term EMA (26 periods) from the short-term EMA (12 periods). An EMA is a sort of moving average (MA) that gives the most recent data points more importance and weight.

The exponentially weighted moving average is another name for the exponential moving average. In comparison to a simple moving average (SMA), which gives equal weight to all observations across the time, an exponentially weighted moving average responds more strongly to recent price movements.

Learning from MACD

When the 12-period EMA, denoted by the red line on the price chart, is higher than the 26-period EMA, denoted by the blue line in the price chart, MACD has a positive value (represented by the blue line in the lower chart), and it has a negative value when the 12-period EMA is lower than the 26-period EMA. The MACD's amount of deviation from or above its baseline reflects how far apart the two EMAs are from one another.

The two EMAs applied to the price chart in the following chart may be seen in relation to the MACD (blue) crossing above or below its baseline (red dashed) in the indicator below the price chart.

The distance between MACD and its signal line is graphed using a histogram, which is frequently used to depict MACD (see the chart below). The histogram will be above the MACD's baseline, or zero line, if the MACD is above the signal line. The histogram will be lower than the MACD's baseline if the MACD is below its signal line. The MACD's histogram is used by traders to determine whether bullish or bearish momentum is strong—and maybe overbought or oversold.

Example of MACD Crossovers

A negative indication indicating that it could be time to sell appears when the MACD crosses below the signal line, as is seen on the accompanying chart. In contrast, MACD issues a positive signal when it crosses above the signal line, indicating that the asset's price is likely to enjoy upward momentum. To lessen the risk of being duped and taking a position too soon, some traders wait for a confirmed cross above the signal line before taking a position.

When crossovers follow the dominant trend, they are more trustworthy. After a minor negative correction inside a longer-term uptrend, MACD crosses above its signal line. This is a positive confirmation and suggests that the uptrend will likely continue.

Traders would view a MACD crossing below its signal line after a small upward movement inside a longer-term downtrend as proof that the trend is negative.

Example of Divergence

A divergence occurs when the highs or lows on the MACD surpass the corresponding highs and lows on the price. When MACD creates two rising lows that line up with two falling lows on the price, a bullish divergence is created. When the long-term trend is still in the favour, this is a reliable bullish indication.

Even when the long-term trend is negative, some traders may seek for positive divergences since they can indicate a shift in trend, however this strategy is less accurate.

A bearish divergence has occurred when MACD creates a sequence of two falling highs that coincide with two rising highs on the price. A long-term negative trend is confirmed to be likely to persist if a bearish divergence develops throughout the trend.

During long-term bullish trends, some traders may keep an eye out for bearish divergences since they can indicate trend weakness. It is less trustworthy than a bearish divergence during a negative trend, though.

Example of Rapid Rises or Falls

The security is overbought or oversold and will soon revert to normal levels when MACD rises or falls sharply (the shorter-term moving average pulls away from the longer-term moving average). To confirm overbought or oversold circumstances, traders frequently combine this analysis with the RSI or other technical indicators.

Investors frequently utilise the histogram of the MACD in the same manner that they may use the MACD itself. The histogram may also be used to spot positive or negative crossings, divergences, and sharp increases or decreases. Because there are temporal disparities between signals on the MACD and its histogram, some expertise is required before selecting which is preferable in any particular circumstance.

How do traders use moving average convergence/divergence (MACD)?

The MACD indicator is used by traders to spot shifts in the intensity or direction of a stock's price trend. Because MACD depends on additional statistical ideas like the exponential moving average, it may appear confusing at first (EMA). Fundamentally, though, MACD aids traders in identifying instances where a stock's recent price movement may indicate a shift in the underlying trend. This can aid traders in determining whether to start, increase, or close a position.

Conclusion

MACD is a useful moving-average technique that works well with daily data. A crossing of the MACD above or below its signal line may also produce a directional signal, much as a crossover of the nine- and 14-day SMAs may do for some traders.
Because MACD is based on EMAs, which give more weight to recent data, it may respond fast to changes in the direction of the current price move. But such rapidity has its drawbacks as well. Crossovers of the MACD lines should be observed, but additional technical indications, such as the RSI or possibly a few candlestick price charts, should be examined for confirmation. Additionally, it claims that because it is a lagging indicator, it argues that confirmation in subsequent price action should develop before taking the signal.

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