Developed by Gerald Appeal in the late 1970s, Moving Average Convergence Divergence (MACD) is a popular momentum indicator or tool that is prevalently used in technical analysis. This tool helps understand the momentum and the directional strength by evaluating the difference between two time periods.
For those unfamiliar with this tool and who wish to make the most out of their trading and investments, this article covers MACD in detail. Let’s read further and find out more about this tool.
What is Moving Average Convergence Divergence?
Moving Average Convergence Divergence (MACD) is a technical indication tool that is majorly used to discover moving averages that indicate a new trend, whether bearish or bullish. With the help of a MACD chart, you will get to see three numbers used for the settings.
- The first one is the number of periods that helps calculate the faster-moving average.
- The second number is that of periods used in the slower moving average.
- The third one is the number of bars used to evaluate the moving average of the difference between slower and faster moving averages.
For instance, if there were 14, 26, and 9 as the MACD parameters, you will interpret it as:
- The 14 signifies a moving average of the last 14 bars.
- The 26 signifies a moving average of the last 26 bars.
- The 9 signifies a moving average of the difference between the two moving averages as mentioned above.
What is MACD in Stock Market?
In the stock market, the MACD is used to interpret the positives and negatives. In the chart, whenever the 12-period EMA is above the 26-period EMA, the MACD offers a positive value. And, if the 12-period EMA is below the 26-period EMA, it offers a negative value. The more distant the MACD is below or above the baseline, it signifies the growing distance between the two EMAs.
Often, MACD is showcased with a histogram, which outlines the distance between the MACD and the signal line. In a situation when the MACD is above the signal line, the histogram will be above the baseline of the MACD. If the MACD goes below the signal line, the histogram will also go below the baseline.
When to Use MACD?
If you are waiting for the best time to use MACD, know there is no best time. The MACD offers insights on possible divergence in any given time frame on the chart. Also, the best time frame you can use with MACD depends on the instrument, trade type, and stock you wish to create and execute a strategy for.
Moving Average Convergence Divergence Formula (MACD Formula)
The formula to calculate MACD is:
MACD = 12-Period EMA – 26-Period EMA
This indicator is calculated by subtracting the long-term EMA, 26 periods, from the short-term EMA, 12 periods. An Exponential Moving Average (EMA) is a kind of Moving Average (MA) that puts a greater weight and importance on the latest data points.
The EMA is also known as the exponentially weighted moving average. It reacts more suggestively to the latest price changes than a Simple Moving Average (SMA), which smears an equal weight to every observation in the period.
How to Calculate MACD?
The MACD showcases the changing relation of short-term exponential moving averages to long-term exponential moving averages. In a MACD chart, the short-term and long-term moving averages come close together (converge), move apart (diverge) and cross over each other. This equation is used to calculate the moving average convergence divergence.
Typically, analysts and traders use closing prices for 12-day and 26-day periods to create EMAs used to evaluate the MACD. After this, a 9-day moving average for the MACD line is plotted along the indicator that acts as a signalling line, helping to illuminate when a market might be turning.
The image above specifies the MACD line, the signalling line and the MACD histogram. These represent the difference between the MACD and the 9-day moving average. The histogram turns positive when the MACD Oscillator line crosses and moves beyond the 9-day average, which is the signalling line. On the contrary, the histogram turns negative when the MACD goes below the signalling line.
12-period and 26-period values are used settings to evaluate the MACD. Any change in the time period used for the calculation can be made to put up the specific trade goals of a trader or a specific trading style.
MACD Trading Strategy
Traders generally use MACD to discover changes in the severity or direction of a stock’s price trend. At first glance, the entire concept of MACD may turn out to be a complicated one as it depends on extra statistical concepts, such as EMA.
However, primarily, MACD assists traders in finding out when the latest momentum in the price of a stock might signal a change in the underlying trend. This, in turn, helps traders decide when to enter, exit or add to a position.
Using MACD with other Indicators
Since it is a versatile trading tool that helps reveal price momentum, MACD is also helpful in determining the direction and price trends. Although the MACD indicator is strong enough to work as a standalone tool, its predictive functionality isn’t absolute. Thus, MACD can improve your advantage as a trader when used with other indicators.
If you have to comprehend the trend strength and a stock’s direction, overlaying the moving average lines onto the MACD histogram will be extremely useful.
Conclusion
Now that you have understood the meaning of moving average convergence divergence and know how to use it, you can move forward and calculate to comprehend how stocks are performing. This way, you bring momentum and trend into one indicator. As an investor, you can apply this trend to daily, weekly and monthly charts.
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