Trading with MACD

Moving Average Convergence-Divergence

(MACD) was originally constructed by Gerald Appel an analyst in New York. Originally designed for analysis of stock trends, it is now widely used in many markets.

MACD is constructed by making an average of the difference between two moving averages. The difference of the original two moving averages and the moving average of the difference can be plotted as two lines, one fast and one slow

How is it Use?

MACD measures the difference between two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average (blue) and the slower moving average (red) is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.

MACD Bullish Signals

MACD generates bullish signals from two main sources:

1.Positive Divergence
2.Bullish Centerline Crossover

1.Positive Divergence:A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher Lows or a second Low that is higher than the previous Low. Positive Divergences are probably the least common of the three signals, but are usually the most reliable, and lead to the biggest moves.

2.Bullish Centerline Crossover:A Bullish Centerline Crossover occurs when MACD moves above the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive, or from bearish to bullish. After a Positive Divergence and Bullish Centerline Crossover, the Bullish Centerline Crossover can act as a confirmation signal. Of the three signals, moving average crossover are probably the second most common signals.

MACD Bearish Signals

MACD generates bearish signals from two main sources. These signals are mirror reflections of the bullish signals:

1.Negative Divergence [Please click on the chart below to see a bigger image]

2. Bearish Centerline Crossover [Please click on the chart below to see a bigger image]

MACD histogram

When the MACD histogram is above zero (the MACD line is above the signal line) this is an indication that positive momentum is increasing. Conversely when the MACD histogram is below zero this is an indication that negative momentum is increasing. The higher or lower the histogram goes above or below zero the greater the momentum of the trend is thought to be.