The Moving Average Convergence/Divergence (MACD, pronounced “mack dee”), is a “momentum” and “trend direction” indicator, predicting the general direction and strength of a stock trend in the short-to-medium term. A MACD technical indicator is widely used, but often not interpreted correctly.
What is MACD in Stock Charts?
The “momentum” of price movement is the force moving a stock’s price. Momentum refers to the strength or weakness at which the price is moving in the current direction. Momentum typically increases as a trend gets under way.
MACD basically plots the difference between a fast moving average line and a slow moving average line. A slower moving average takes the average of a long period of time.
A faster moving average takes the average of a shorter period of time, which tracks the current price more aggressively, though it is more “choppy” or “noisy”. MACD plots the difference between these fast and slow averages.
The MACD line displays swings above and below a zero center line, but MACD is NOT an “oscillator indicator,” as some traders believe.
Oscillator indicators, such as the Relative Strength Index (RSI) and the stochastic oscillator, reveal overbought and oversold conditions. Momentum indicators, such as the MACD technical indicator, follow the acceleration of price trends, and can predict continued trends or reversals.
Stochastic Oscillator Warning
In fact, DO NOT use a stochastic oscillator with MACD. MACD is designed to be used during trending periods, while stochastics are designed to be used in a different market condition, determining overbought and oversold conditions.
Stochastics are unreliable in a trending market. Use candlestick patterns in conjunction with MACD lines in a trending market for more accurate interpretations.
When the MACD Trend Indicator Works Best
The MACD formula uses time and price in it’s calculation, which is excellent for tracking the acceleration of price. It does not, however, include the third most valuable ingredient, namely volume.
The originator of MACD intended this indicator to be used in conjunction with other stock market technical indicators in order to get a more trustworthy overall picture. To confirm MACD signals, also use volume in your analysis.
MACD works best in a moderate trending situation. Because it is a trend indicator, it does not work well during periods of sideways action, or you’ll likely be “whipsawed” with false buy and sell signals. And interestingly, MACD’s results are more trustworthy on rising prices than on falling prices.
Moving averages lag behind price movements. Because of this lag, MACD works better with longer time frames, so it’s fine for swing trading, but it’s not so good for day trading.
Understanding MACD: How is it Calculated?
The MACD line is calculated by the 12-day exponential moving average (EMA), the faster moving line, minus the slower moving 26-day exponential moving average. These are calculated on closing prices.
This shows whether the stock’s price action has been trending up or down recently. The default values of 12 and 26 work fine for swing traders, although charts usually give the option to change these values.
Price always moves toward or away from an underlying average, and the relationship between them uncovers price momentum and trend, which is the concept behind the MACD technical indicator.
Plotting the MACD Lines
The MACD line is plotted around a zero center line. When the MACD line goes up, it means the 12- and 26-day EMAs are moving further away from each other. This indicates momentum is accelerating.
When the 12-day EMA and 26-day EMA cross each other, the MACD line shows this by crossing the zero center line. This means there is little or no momentum.
There is a second line, called the “signal line,” whose default setting is the 9-day exponential moving average of the MACD line. It “smooths” out the MACD line, and so lags a little behind it.
How to Use the MACD
The gap between the MACD line and the signal line is part of understanding this indicator. When the gap narrows, you’re heading into a sideways action, that is, with little price movement. When the gap widens, an acceleration of price movement is developing.
Generally, when the MACD line (the faster line) crosses above the lagging signal line, and both lines are below zero, this indicates upside momentum (and a possible buy entry point).
Similarly, when the MACD line crosses below the signal line, the signal indicates momentum to the downside. A crossover point may not necessarily mean a reversal. It may simply indicate a continuation of the trend, just at a different rate.
Points where the two lines cross are not necessarily points to enter a trade, either, especially during sideways movements. Care must be taken by using additional indicators or trendlines for confirmation.
MACD Indicates Trends
• When the MACD line crosses ABOVE the center line, an uptrend is indicated.
• When the MACD line crosses BELOW the center line, a downtrend is indicated.
MACD Indicates Bull And Bear Markets
• MACD indicates a bull market when the MACD line is greater than the zero line AND greater than the trigger line.
• MACD indicates a bear market when the MACD line is less than the zero line AND less than the trigger line.
MACD Indicates Possible Buy And Sell Points
• A BUY signal is indicated when the MACD line crosses ABOVE the signal line.
• A SELL signal is indicated when the MACD line crosses BELOW the signal line.
Remember to always confirm entry and exit points with another indicator.
Here’s a good example of how MACD can help confirm an uptrend. Suppose a stock’s price is rising. We normally confirm an uptrend direction by seeing if the rise is on unusually high volume.
If the volume is not especially high, however, we can use MACD to visually confirm that an uptrend is in progress.
MACD Histogram Indicator
In addition to the MACD line and the signal line is the MACD histogram indicator, which is a bar-type display that clearly shows a change in a price’s momentum. It is calculated as the difference between the MACD line and the signal line.
The histogram bars grow longer as price momentum accelerates, and become shorter as momentum wanes. You can visually see on a chart that the distance between the MACD line and the signal line narrowing or expanding, which is also graphically displayed by the histogram bars.
The MACD histogram indicator can give a little faster alert to changes than the MACD and signal lines alone.
When the MACD line and the signal line cross each other, the histogram bars drop to the zero line, indicating there is no difference between the two lines and therefore, little movement of price.
When a trend begins, we normally see an increase in momentum. As a trend ages, it usually begins to wane. A decrease in momentum tells us that the direction the price was moving in is coming to a close, and possibly a change in direction may even be in the wings.
When the MACD line is above the signal line, the MACD histogram plots bars above the histogram’s zero line. When the MACD line is below the signal line, the histogram plots bars below the zero line.
Always Get Confirmation
No one indicator is foolproof, and MACD is not a perfect indicator. MACD, however, can tell us a lot, and is another important tool in your technical analysis toolbox.
Do not use moving averages as a confirmation of the MACD technical indicator, however, since MACD is based on moving average data. Use volume and candlesticks together with MACD to form a more accurate prediction.