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.
How to use the MACD indicator
The MACD takes the difference between two exponential moving averages (using closing prices) – the 12-day EMA and the 26-day are the most commonly used. Then the “signal line” (a 9-day SMA of the MACD itself) is placed over the MACD. It’s called the ‘signal line’ because when the MACD line crosses it, it’s a signal to either buy or sell.
Crossovers – when the MACD line goes above the signal line, it suggests an upward trend meaning it may be time to buy. When it crosses below, it suggests a downward trend and it may be time to sell. Similarly, when MACD crosses above the base line, an upward direction is assumed and hence a signal to buy. On the other hand, when the MACD falls below the base line, a downward direction is assumed and hence a sell signal is generated.
Divergence – this is when the price line goes in a different direction from the MACD. It suggests that a trend might be about to reverse and therefore can help traders pinpoint opportunities.
Dramatic rise – when there’s a stark difference between the slow and fast EMAs (meaning a steep incline in the MACD line) it’s a signal that the asset is overbought.