MOVING AVERAGE CONVERGENCE/DIVERGENCE (MACD)

MACD INTRODUCTION

Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend-following characteristics. These lagging indicators are turned into a momentum oscillator by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. MACD is a centered oscillator and the guidelines for using centered oscillators apply.

MACD Formula:

The most popular formula for the "standard" MACD is the difference between a security's 26-day and 12-day Exponential Moving Averages (EMAs). Appel and others have since tinkered with these original settings to come up with a MACD that is better suited for faster or slower securities. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator.

Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. Usually, a 9-day EMA of MACD is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above its 9-day EMA, and a bearish crossover occurs when MACD moves below its 9-day EMA. The histogram represents the difference between MACD and its 9-day EMA. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

What Does MACD Do?

MACD measures the difference between two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average and the slower moving average is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.

MACD Bullish Signals:

MACD generates bullish signals from three main sources:

1.Positive Divergence
2.Bullish Moving Average Crossover
3.Bullish Centerline Crossover

POSITIVE DIVERGENCE:


A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher lows or a second low that is higher than the previous low.

BULLISH MOVING AVERAGE CROSSOVER:
A Bullish Moving Average Crossover occurs when MACD moves above its 9 day EMA. This can be considered valid when a bullish moving avg crossover occurs after the MACD line makes its second higher low, due to many times it may give a false signals.

BULLISH CENTERLINE CROSSOVER:
A Bullish Centerline Crossover occurs when MACD moves about the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive. After a positive divergence and bullish centerline crossover, the bullish centerline crossover can act as a confirmation signal.

MACD Bearish Signals

MACD generates bearish signals from three main sources. These signals are mirror reflections of the bullish signals:

1.Negative Divergence
2.Bearish Moving Average Crossover
3.Bearish Centerline Crossover

NEGATIVE DIVERGENCE:
A Negative Divergence forms when the security advances or moves sideway, and the MACD declines. The negative divergence in MACD can take the form of either a lower high or a straight decline.

BEARISH MOVING AVERAGE CROSSOVER:
A bearish moving average crossover occurs when MACD declines below its 9 day EMA Most of the times these signal gives false signals. So moving average crossovers should be confirmed with other signals to avoid false readings.

BEARISH CENTERLINE CROSSOVER:
A Bearish Centerline crossover occurs when MACD moves below zero and into negative territory. This is a clear indication that momentum has changed from positive to negative. The centerline crossover can act as an independent signal or confirm a prior signal such as a moving average crossover or negative divergence. Once MACD crosses into negative territory, momentum, at least for the short term, has turned bearish.

MACD-HISTOGRAM
The MACD-Histogram represents the difference between the MACD and its trigger line, the 9-day EMA of MACD. The plot of this difference is presented as a histogram, making centerline crossovers and divergences easily identifiable. A centerline crossover for the MACD-Histogram is the same as a moving average crossover for MACD. If you will recall, a moving average crossover occurs when MACD moves above or below the trigger line.

If the value of MACD is larger than the value of its 9-day EMA, then the value on the MACD-Histogram will be positive. Conversely, if the value of MACD is less than its 9-day EMA, then the value on the MACD-Histogram will be negative.

Further increases or decreases in the gap between MACD and its trigger line will be reflected in the MACD-Histogram. Sharp increases in the MACD-Histogram indicate that MACD is rising faster than its 9-day EMA and bullish momentum is strengthening. Sharp declines in the MACD-Histogram indicate that MACD is falling faster than its 9-day EMA and bearish momentum is increasing.