MACD, short for moving average convergence/divergence is a technical indicator used to reveal changes in stock prices, strength, momentum, direction and duration of trend. It was developed by Gerald Appel in 1970. It shows relationship between two moving averages of stock price. It is calculated by deducting the 26 period exponential moving average from 12 period exponential moving average. The result of calculation is MACD line. A nine day exponential moving average is plotted on top of the MACD line, it is called signal line. It function as trigger for sell and buy signals for traders. The traders may sell security when MACD line crosses below the signal line, or buy the security when MACD crosses above the signal line.
The moving average convergence divergence can be understood in numerous ways, but more communal methods are crossovers, divergence and rapid rise fall.
MACD Crossovers – A nine day exponential moving average is plotted over the MACD line. It is called signal line which act as key for buy and sell signals. When MACD lines crosses over the signal line, it indicate bullish signal while when MACD lines crosses below the signal line, it is an indication of bearish market trend. Successful traders wait for the confirmed cross before entering a position to cut the chance of fake price movement.
MACD Divergence – when MACD procedures highs and lows which are differ from highs and lows of price, it is called divergence. A bullish divergence seems when moving average convergence divergence procedures two rising lows that resembles with two falling lows on price chart. It is strong and valid bullish signal. When MACD forms two decreasing high that resembles with two mounting highs on the price chart, a bearish divergence has been made. A bearish divergence that appears during long bearish trend is considered confirmation that the trend will continue, while some traders watch bearish divergence during long bullish trend, with the belief that, it’s time of trend reversal.
MACD Rapid Rise and fall – the rapid rise and fall indicate that the stock or security is oversold or overbought and soon price will return to normal range. Successful traders usually combine MACD analysis with Relative Strength Index to verify oversold or overbought conditions.
MACD is considered one of the best technical indicators used to identify market trends, but still have some limitations as well. One of the major issues is that it frequently signal a likely reversal but no actual reversal really happen. Another issue is that, it cannot forecast all reversals. In other words, it forecast various reversals that does not happen actually.