In financial research, the Moving Average Convergence Divergence (MACD) technical indicator is a flexible and popular tool. Gerald Appel developed the this momentum oscillator in the late 1970s, which provides data on trend strength, potential reversals, and the relationship between moving averages.
The MACD is a momentum and trend-following indicator that aids analysts and traders in recognizing the convergence and divergence between two moving averages. On a chart, it is shown as a histogram and a signal line. It is used to offer entry and exit signals, assess the strength of trends, and spot potential trend reversals.
The following steps are used to compute the MACD
- Calculate the Short-term EMA: Calculate the Short-term Exponential Moving Average (EMA) by averaging the asset’s price over a shorter time frame, typically 12 periods.
- Calculate the Long-term EMA: Calculate the asset’s price’s long-term exponential moving average (typically 26 periods).
- Calculate MACD Line: To get the line, subtract the long-term EMA from the short-term EMA.
- Calculate the Signal Line: To obtain the signal line, calculate the EMA of the MACD line for a predetermined time period (often 9 periods).
- Calculate the histogram: The difference between the MACD line and the signal line is the histogram. It depicts the separation between the two lines and shows where they converge or diverge visually.
Interpretation and Significance
There are several ways to interpret the MACD:
- MACD Line and Signal Line Crossovers: A bullish signal is produced when the MACD line crosses above the signal line, signaling potential upward momentum. In contrast, a bearish signal is produced when this line crosses below the signal line, indicating probable downward momentum.
- Analysis of the Histogram: The height of the histogram shows the distance between the MACD line and the signal line. Histogram bars that are positive or negative imply bullish momentum or bearish momentum, respectively.
- Crossings of the Zero Line: This signal indicates potential bullish momentum when the MACD line crosses above the zero line. In contrast, a crossing of this line below the zero line denotes probable bearish momentum.
MACD applications
- Trend Confirmation: This indicator is used to confirm trends. While negative MACD values signify downward movement, positive values show rising momentum.
- Crossover Signal: Signal line and MACD line crossings are used by traders to produce buy and sell signals. These crossovers aid in locating probable sites of entry and exit.
- Histogram Analysis: Analyzing a histogram might give you information about how strong a trend is. Histogram bars that are increasing or dropping show momentum that is strengthening or weakening.
- Divergence Analysis: When the price and MACD line move in opposing directions, there is a divergence. Bullish divergence, which denotes possible upward momentum, happens when the price makes lower lows while it makes higher lows. When the price makes higher highs while the MACD makes lower highs, this is referred to as bearish divergence and may indicate future negative momentum.
Historical Context
Richard Donchian’s original idea was improved by Gerald Appel in the late 1970s when he introduced the MACD. Due to the indicator’s ease of use and efficiency in spotting trends and potential trading signals, it has become very popular.
Risques and Restrictions
- Lagging Indicator: Like other technical indicators, it is a lagging indicator because it is reliant on historical price data, which could cause delays in signal formation.
- Misleading Signals: It can produce misleading signals in sideways or range-bound markets, despite the fact that it works well in trending markets.
- Optimal parameter Signal: A market’s peculiarities must be taken into account while choosing the best parameters (short- and long-term periods) for this to work well.