What is MACD and How Do Traders Use it?
MACD is an abbreviation for Moving Average Convergence Divergence. It falls into the trend-following type of analysis – which plots momentum through two moving averages of the asset’s price. It is the difference between the 26-day EMA (exponential moving average) and the 12-day EMA. In addition a 9-day EMA is plotted – this is referred to as the signal line and as the name indicates signals points where short or long positions can be taken.
There are three primary ways that MACD is analyzed: Dramatic Rise, Crossover, Divergence
A significant rise in the MACD i.e. the shorter term MA starts moving away from the longer MA (moving average). This pattern usually points to an overbought asset. Most investors also use RSI to confirm the price is in the overbought region and avoid false signals.
As the name indicates when the MACD crosses the signal line with a downward vector, the indicator is giving a bearish signal, point towards short positions. If the MACD’s direction is inversed, crossing the signal line from below and moving up, then a bullish signal is given. Usually investors act only when the crossover has been observed to hold, as a reversal or a false signal is a possibility.
When the price of your asset pulls away from the MACD this usually indicates a reversal of the current trend. In this scenario, the price will usually move inversely to the MACD – so the indicator will recede as the price climbs for example.
Once again, these movements or relationship are usually cross-referenced against other indicators to avoid false signals or temporary fluctuations.
Another element of the MACD is the zero line – when the averages move above or below the line, it can show upwards momentum or the continuation of a downward trend. The zero line is found at the point where the MACD averages cross. Signals given when the EMAs cross the zero line, generally lag behind the other signals the indicator produces as the line must continue the trend for longer before it reaches the line.