The Moving Average Convergence Divergence commonly known as MACD is a momentum based technical indicator. As the name suggests, this indicator relies on Moving Average for analyzing the momentum of a stock.
It is used by traders world wide to identify trend and momentum directions and spot possible reversals. Let me now get into the detailed aspects of this indicator.
Components :
MACD consists of 2 lines.
- MACD Line - This is the blue line in the picture above. MACD Line is basically the difference between the 12 day and 26 day Exponential Moving Averages. It is a moving average crossover line.
- Signal Line- This is the red line in the above picture. This is basically the 9 day exponential moving average of the MACD line.
Histogram - Apart from the 2 lines, there are these red histograms depicted in the chart above. This indicator oscillates above or below Zero.
MACD Histogram - is the difference in value between the MACD and the Signal line.
MACD Trade Strategies :
When traders use the MAC Dee indicator, they usually look at 3 identifiers for their trades.
- Zero Line crossovers
- Signal Line crossovers
- Divergences
Whenever the 2 MACD lines are very close to each other, the histograms will be close to 0. This indicates that there is less strength in the momentum.
In the chart above, when the price gives a break out at the point #1, the 2 lines also separate and the historgrams goes much above 0.
When the 2 lines separate from each other, which can also be seen at #2 in the chart above, it indicates the beginning of a new uptrend. With the MACD line also above the signal line.
At point #3, there is a negative divergence, which indicates that a trend reversal could be on the way. After this divergence, you can see the start of a downtrend in price.
Point #4 in the chart is depicting a strong momentum in the downtrend of the price. It is indicated by 2 things. 1) The MACD has crossed the Signal line from above and is staying below it. 2) The histogram have falled significantly below Zero, depicting strength in the selling.
Conclusion :
MACD is a good momentum indicator but it is not perfect. If you start using this indicator you will notice that you could have significant price failures.
So this indicator is best used when it combined with others to be used as a mere confirmation tool. This will help you to evolve as a trader and also identify potential entry and exit prices. It is a great tool to identify the trend and its momentum. But not the best indicator when used alone.
Thank you for reading.
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