The MACD Indicator or Moving Average Convergence Divergence Indicator is one of the most popular measures used by stock traders and investors who use technical analysis as a part of their repertoire. However, one popular method for using the MACD Indicator can cost you money if you are not careful.
For those who wish to understand the MACD calculation please see the end of this article.
Before describing how to use the MACD Indicator let's look at its definition. Often called the “Mac-D”, Gerald Appel developed this momentum oscillator based on Exponential Moving Averages (EMA). The MACD Indicator is comprised of three parts:
The chart below shows the MACD Indicator for a two-year DJIA chart. It shows where to find the periods for the EMAs used to calculate the MACD fast line (12, 26) and the period used to calculate the signal line (9). You can change these periods through most stock charting software.
The MACD fast line is black, the MACD signal line is red, and the MACD histogram is in blue bar chart. Buy, sell, and trend signals are derived from each of these components.
-sell signals are given when the fast line crosses over the signal line. When the MACD fast line rises up through the MACD signal line, we receive a buy signal. Conversely, when the MACD fast line falls through the MACD signal line we receive a sell signal. The appeal of this approach is it is a simple.
In the chart below, we see several examples of how the crossover of MACD Indicator buy-sell signal works. The green arrows shows buy signals and the red arrow shows sell signals. In the chart below, most of the time, the signals worked as expected. However, the MACD Indicator also gave several false sell signals on this chart. False indications are the chief problem with the MACD Indicator buy-sell signal.
The crossover MACD Indicator buy-sell signal works well in markets that are trending either up or down. However, the MACD Indicator buy-sell system will deliver more signals that are false when the trend is changing or flat. On the chart below the false signals came when the market was in transition from a bull trend to a bear (December 2007), or when the market was trending flat (August – September 2008). Traders or investors that followed these sell signals blindly were disappointed and may have reacted by buying back at the wrong time. While useful, the MACD Indicator buy-sell signal is not always right and can be misleading, if used without confirmation. This is especially true when we are facing markets that are choppy or trending sideways.
Investors also use the MACD Indicator to identify divergence from the current market trend. Known as MACD divergence, this technique helps to identify changes in the market trend. If a stock makes a new recent high but the MACD Indicator makes a lower high on the chart that is a negative divergence and indicates that the buying power has diminished. On the other hand, if a stock makes a new recent low but the MACD Indicator has a higher low known as a positive divergence. It means the selling pressure has dried up.
Once again looking at the two-year chart of the DJIA, we can identify three examples of MACD divergence. In late 2007, the DJIA made a new all time high and there seemed to be support forming in the 12,700 area. However, the MACD displayed negative divergence by not rising above the prior high reached in October 2007. This signaled that the DJIA was more likely to turn down, which it did. Since this is a daily chart, you should not interrupt that this signal was the end of the long-term bull market and the beginning a new bear market. Rather, it just indicated that investors should expect the DJIA to move down over the next several months.
In the summer of 2008, the MACD Indicator gave us another negative divergence signal with the DJIA rising from July through early September and the MACD Indicator was unable to rise above its prior high. Once again, this indicator told us to expect the market to turn down, rather than keep rising.
Finally, in early 2009 the MACD Indicator produced a positive divergence signal. The DJIA was trending down and the MACD turned up before reaching its prior low. This MACD positive divergence signal told us to expect the DJIA to move up past the DJIA downtrend line.
In each case, the divergence on the MACD Indicator provided a good signal that a change in the trend of the DJIA was about to begin, or was beginning. MACD divergence is one of the best uses of the indicator. The only problem is it can take time for the divergence to show up. This means you should be on the lookout for divergence showing up, recognizing that it can take some time before you receive a good signal.
Some investors use divergence on the MACD histogram to provide them with buy and sell signals. The MACD histogram measures the difference of the MACD fast line minus the MACD signal line. Negative divergence occurs on the MACD histogram when the following high on the graph is lower than the previous high and the trend of the stock or index is flat or trending up. Positive divergence on the MACD histogram occurs when the following low is higher than the previous low and the trend of the stock or index is flat to down.
On the chart below there are three times when the MACD histogram showed negative divergence from the DJIA. In each case, the signal was correct. When using MACD histogram divergence, it is preferable to have confirmation from another indicator along with signs of support or resistance.
At Trading Online Markets, we use the MACD Indicator and the MACD histogram to help identify buy and sell signals as well as trend changes on all of our charts. However, we include other indicators to confirm the signal given by the MACD Indicator. In addition, we employ support and resistance levels to derive the best market signals that have helped us beat the market every year since our inception. You will see some examples of this application in our publicly available monthly stock trend charts.
Often called the “Mac-D”, Gerald Appel developed this momentum oscillator based on Exponential Moving Averages (EMA). It calculates the difference in these moving averages to develop an indicator called the MACD fast line. Traditionally the 12 and 26 period EMAs are used.
The MACD signal line is an EMA of the MACD fast line. Traditionally, the 9 period EMA of the MACD fast line is used.
The MACD histogram is a bar chart that shows the difference between the MACD fast line and the MACD signal line (MACD fast line – MACD signal line).
Most charting systems such as StockCharts allow you to adjust the periods used to calculate the MACD Indicators.