MACD Chart explained

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Moving Average Convergence Divergence – MACD

What Is Moving Average Convergence Divergence – MACD?

Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.

The result of that calculation is the MACD line. A nine-day EMA of the MACD called the “signal line,” is then plotted on top of the MACD line, which can function as a trigger for buy and sell signals. Traders may buy the security when the MACD crosses above its signal line and sell – or short – the security when the MACD crosses below the signal line. Moving Average Convergence Divergence (MACD) indicators can be interpreted in several ways, but the more common methods are crossovers, divergences, and rapid rises/falls.

Moving Average Convergence Divergence – MACD

The Formula for MACD:

MACD is calculated by subtracting the long-term EMA (26 periods) from the short-term EMA (12 periods). An exponential moving average (EMA) is a type of moving average (MA) that places a greater weight and significance on the most recent data points. The exponential moving average is also referred to as the exponentially weighted moving average. An exponentially weighted moving average reacts more significantly to recent price changes than a simple moving average (SMA), which applies an equal weight to all observations in the period.

Key Takeaways

  • MACD is calculated by subtracting the 26-period EMA from the 12-period EMA.
  • MACD triggers technical signals when it crosses above (to buy) or below (to sell) its signal line.
  • The speed of crossovers is also taken as a signal of a market is overbought or oversold.
  • MACD helps investors understand whether the bullish or bearish movement in the price is strengthening or weakening.

Learning From MACD

The MACD has a positive value whenever the 12-period EMA (blue) is above the 26-period EMA (red) and a negative value when the 12-period EMA is below the 26-period EMA. The more distant the MACD is above or below its baseline indicates that the distance between the two EMAs is growing. In the following chart, you can see how the two EMAs applied to the price chart correspond to the MACD (blue) crossing above or below its baseline (red dashed) in the indicator below the price chart.

MACD is often displayed with a histogram (see the chart below) which graphs the distance between the MACD and its signal line. If the MACD is above the signal line, the histogram will be above the MACD’s baseline. If the MACD is below its signal line, the histogram will be below the MACD’s baseline. Traders use the MACD’s histogram to identify when bullish or bearish momentum is high.

MACD vs. Relative Strength

The relative strength indicator (RSI) aims to signal whether a market is considered to be overbought or oversold in relation to recent price levels. The RSI is an oscillator that calculates average price gains and losses over a given period of time; the default time period is 14 periods with values bounded from 0 to 100.

MACD measures the relationship between two EMAs, while the RSI measures price change in relation to recent price highs and lows. These two indicators are often used together to provide analysts a more complete technical picture of a market.

These indicators both measure momentum in a market, but, because they measure different factors, they sometimes give contrary indications. For example, the RSI may show a reading above 70 for a sustained period of time, indicating a market is overextended to the buy side in relation to recent prices, while the MACD indicates the market is still increasing in buying momentum. Either indicator may signal an upcoming trend change by showing divergence from price (price continues higher while the indicator turns lower, or vice versa).

Limitations of MACD

One of the main problems with divergence is that it can often signal a possible reversal but then no actual reversal actually happens – it produces a false positive. The other problem is that divergence doesn’t forecast all reversals. In other words, it predicts too many reversals that don’t occur and not enough real price reversals.

“False positive” divergence often occurs when the price of an asset moves sideways, such as in a range or triangle pattern following a trend. A slowdown in the momentum – sideways movement or slow trending movement – of the price will cause the MACD to pull away from its prior extremes and gravitate toward the zero lines even in the absence of a true reversal.

Additional MACD Resources

Are you interested in using MACD for your trades? Check out our own primer on the MACD and Spotting Trend Reversals with MACD for more information.

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If you’d like to learn about more indicators, Investopedia’s Technical Analysis Course provides a comprehensive introduction to the subject. You’ll learn basic and advanced technical analysis, chart reading skills, technical indicators you need to identify, and how to capitalize on price trends in over five hours of on-demand video, exercises, and interactive content.

Example of MACD Crossovers

As shown on the following chart, when the MACD falls below the signal line, it is a bearish signal which indicates that it may be time to sell. Conversely, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Some traders wait for a confirmed cross above the signal line before entering a position to reduce the chances of being “faked out” and entering a position too early.

Crossovers are more reliable when they conform to the prevailing trend. If the MACD crosses above its signal line following a brief correction within a longer-term uptrend, it qualifies as bullish confirmation.

If the MACD crosses below its signal line following a brief move higher within a longer-term downtrend, traders would consider that a bearish confirmation.

Example of Divergence

When the MACD forms highs or lows that diverge from the corresponding highs and lows on the price, it is called a divergence. A bullish divergence appears when the MACD forms two rising lows that correspond with two falling lows on the price. This is a valid bullish signal when the long-term trend is still positive. Some traders will look for bullish divergences even when the long-term trend is negative because they can signal a change in the trend, although this technique is less reliable.

When the MACD forms a series of two falling highs that correspond with two rising highs on the price, a bearish divergence has been formed. A bearish divergence that appears during a long-term bearish trend is considered confirmation that the trend is likely to continue. Some traders will watch for bearish divergences during long-term bullish trends because they can signal weakness in the trend. However, it is not as reliable as a bearish divergence during a bearish trend.

Example of Rapid Rises or Falls

When the MACD rises or falls rapidly (the shorter-term moving average pulls away from the longer-term moving average), it is a signal that the security is overbought or oversold and will soon return to normal levels. Traders will often combine this analysis with the Relative Strength Index (RSI) or other technical indicators to verify overbought or oversold conditions.

It is not uncommon for investors to use the MACD’s histogram the same way they may use the MACD itself. Positive or negative crossovers, divergences, and rapid rises or falls can be identified on the histogram as well. Some experience is needed before deciding which is best in any given situation because there are timing differences between signals on the MACD and its histogram.

How to Interpret the MACD on a Trading Chart

On a trading chart, the moving average convergence-divergence indicator (MACD) was designed use exponential moving averages of 26 and 12 days, although the MACD is a model into which you can insert any moving average that suits your fancy and backtests well on your security.

A full MACD indicator, as shown in this figure, includes

An indicator line

A trigger (usually a moving average of the indicator, superimposed on top of the indicator)

The arrows in this figure show where you would buy and sell:

Buy: In the MACD indicator window, the crossover of the trigger and the MACD indicator occurs earlier than the crossover of the two moving averages in the top window. Looking from the left, the MACD tells you to buy two days earlier than the moving average crossover.

Sell: The real benefit comes at the next signal — the exit. Here, the MACD tells you to sell over two weeks ahead of the moving average crossover, saving you $4.68, or almost 5 percent.

Reenter: At the right-hand side of the chart, the MACD tells you to reenter, while the moving averages are still lollygagging along and haven’t yet crossed.

The MACD’s forecasting ability makes it one of the most popular indicators. But watch out for attributing too much to it. A shock can come along and cause the price to vary wildly from the trend, whereupon the tendency to converge or diverge becomes irrelevant. A new price configuration develops, and because the MACD is comprised of moving averages, the indicator still lags the price event like any other moving average.

You may find it hard to “read” the MACD indicator, except when the trigger is actually crossing the indicator line. You’re not alone. Another way of displaying the MACD, in histogram format, is much easier on the eye.

In this figure, each bar in the histogram represents the difference between the two moving averages on that date. You don’t use the trigger line in the histogram because you can choose by eye how fast the histogram bars are closing in on the zero line, or diverging from it:

At zero: The two moving averages have the same numerical value — they have zero difference between them.

While the bars grow taller: The difference between the two averages is increasing (divergence), and this movement favors the trend continuing.

When the bars stop growing and start to shrink: The two moving averages are converging — watch out for a signal change.

When the bars are upside down (below zero), the signal is to sell. What do you do when the bars become less negative? This indicator means selling pressure (supply) is running out of steam. Technically, you don’t get a buy signal until the bars are actually over the zero line, but it’s up to you whether to act in anticipation that it will cross the line.

MACD Indicator Explained

The Moving Average Convergence Divergence (MACD) is an oscillator-type indicator that is widely used by traders for technical analysis (TA). MACD is a trend-following tool that utilizes moving averages to determine the momentum of a stock, cryptocurrency, or another tradeable asset.

Developed by Gerald Appel in the late 1970s, the Moving Average Convergence Divergence indicator tracks pricing events that have already occurred and, thus, falls into the category of lagging indicators (which provide signals based on past price action or data). The MACD may be useful for measuring market momentum and possible price trends and is utilized by many traders to spot potential entry and exit points.

Before diving into the mechanisms of MACD, it is important to understand the concept of moving averages. A moving average (MA) is simply a line that represents the average value of previous data during a predefined period. In the context of financial markets, moving averages are among the most popular indicators for technical analysis (TA) and they can be divided into two different types: simple moving averages (SMAs) and exponential moving averages (EMAs). While the SMAs weight all data inputs equally, EMAs assign more importance to the most recent data values (newer price points).

How MACD works

The MACD indicator is generated by subtracting two exponential moving averages (EMAs) to create the main line (MACD line), which is then used to calculate another EMA that represents the signal line.

In addition, there is the MACD histogram, which is calculated based on the differences between those two lines. The histogram, along with the other two lines, fluctuates above and below a centerline, which is also known as the zero line.

Therefore, the MACD indicator consists of three elements moving around the zero line:

The MACD line (1): helps determine upward or downward momentum (market trend). It is calculated by subtracting two exponential moving averages (EMA).

The signal line (2): an EMA of the MACD line (usually 9-period EMA). The combined analysis of the signal line with the MACD line may be helpful in spotting potential reversals or entry and exit points.

Histogram (3): a graphical representation of the divergence and convergence of the MACD line and the signal line. In other words, the histogram is calculated based on the differences between the two lines.

The MACD line

In general, the exponential moving averages are measured according to the closing prices of an asset, and the periods used to calculate the two EMAs are usually set as 12 periods (faster) and 26 periods (slower). The period may be configured in different ways (minutes, hours, days, weeks, months), but this article will focus on daily settings. Still, the MACD indicator may be customized to accommodate different trading strategies.

Assuming the standard time ranges, the MACD line itself is calculated by subtracting the 26-day EMA from the 12-day EMA.

As mentioned, the MACD line oscillates above and below the zero line, and this is what signals the centerline crossovers, telling traders when the 12-day and 26-day EMA are changing their relative position.

The signal line

By default, the signal line is calculated from a 9-day EMA of the main line and, as such, provides further insights into its previous movements.

Although they are not always accurate, when the MACD line and signal line cross, these events are usually deemed as trend reversal signals, especially when they happen at the extremities of the MACD chart (far above or far below the zero line).

The MACD histogram

The histogram is nothing more than a visual record of the relative movements of the MACD line and the signal line. It is simply calculated by subtracting one from the other:

However, instead of adding a third moving line, the histogram is made of a bar graph, making it visually easier to read and interpret. Note that the histogram bars have nothing to do with the trading volume of the asset.

MACD settings

As discussed, the default settings for MACD is based on the 12, 26, and 9-period EMAs – hence MACD (12, 26, 9). However, some technical analysists and chartists change the periods as a way to create a more sensitive indicator. For example, MACD (5, 35, 5) is one that is often used in traditional financial markets along with longer timeframes, such as weekly or monthly charts.

It is worth noting that due to the high volatility of cryptocurrency markets, increasing the sensitivity of the MACD indicator may be risky because it will likely result in more false signals and misleading information.

How to read MACD charts

As the name suggests, the Moving Average Convergence Divergence indicator tracks the relationships between moving averages, and the correlation between the two lines can be described as either convergent or divergent. Convergent when the lines gravitate toward one another and divergent when they move apart.

Still, the relevant signals of the MACD indicator are related to the so-called crossovers, which happen when the MACD line crosses above or below the centerline (centerline crossovers), or above or below the signal line (signal line crossovers).

Keep in mind that both centerline and signal line crossovers may happen multiple times, producing many false and tricky signals – especially in regards to volatile assets, such as cryptocurrencies. Therefore, one should not rely on the MACD indicator alone.

Centerline crossovers

Centerline crossovers happen when the MACD line moves either on the positive or negative area. When it crosses above the centerline, the positive MACD value indicates that the 12-day EMA is greater than the 26-day. In contrast, a negative MACD is shown when the MACD line crosses below the centerline, meaning that the 26-day average is higher than the 12-day. In other terms, a positive MACD line suggests a stronger upside momentum, while a negative one may indicate a stronger drive to the downside.

Signal line crossover

When the MACD line crosses above the signal line, traders often interpret it as a potential buying opportunity (entry point). On the other hand, when the MACD line crosses below the signal line, traders tend to consider it a selling opportunity (exit point).

While the signal crossovers can be helpful, they are not always reliable. It is also worth considering where they take place in the chart as a way to minimize the risks. For instance, if the crossover calls for a buy but the MACD line indicator is below the centerline (negative), market conditions may still be considered bearish. Conversely, if a signal line crossover indicates a potential selling point, but the MACD line indicator is positive (above the zero line), market conditions are still likely to be bullish. In such a scenario, following the sell signal may carry more risk (considering the larger trend).

MACD and price divergences

Along with centerline and signal line crossovers, MACD charts may also provide insights through divergences between the MACD chart and the asset’s price action.

For example, if the price action of a cryptocurrency makes a higher high while the MACD creates a lower high, we would have a bearish divergence, indicating that despite the price increase, the upside momentum (buying pressure) is not as strong as it was. Bearish divergences are usually interpreted as selling opportunities because they tend to precede price reversals.

On the contrary, if the MACD line forms two rising lows that align with two falling lows on the asset price, then this is considered a bullish divergence, suggesting that despite the price decrease the buying pressure is stronger. Bullish divergences tend to precede price reversals, potentially indicating a short-term bottom (from a downtrend to an uptrend).

Closing thoughts

When it comes to technical analysis, the Moving Average Convergence Divergence oscillator is one of the most useful tools available. Not only because it is relatively easy to use, but also because it is quite effective at identifying both market trends and market momentum.

As most TA indicators, however, the MACD is not always accurate and may provide numerous false and misleading signals – especially in relation to volatile assets or during weak-trending or sideways price action. Consequently, many traders use MACD with other indicators – such as the RSI indicator – to reduce risks and to further confirm the signals.

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