“Moving Average Convergence or Divergence”, MACD or MAC-D, is the more refined way of using the concept of moving averages to identify or signal trends. If you are a novice trader, you need to first understand the EMA (exponential moving averages) to apply and understand MACD itself. So what aspect of moving averages, does it build on? MACD refines the two moving averages system that we earlier saw in the concept of “price crossovers”. It is an oscillator that measures the momentum of an asset’s price using three signals and combining them as one. It is based on the MACD line, the signal line and the divergence.
How it is calculated?
Gerald Appel developed this tool and he defined a standard formula for it. The EMA forms the basis of it as the MACD line itself is the difference of two EMAs; a faster EMA and a slower EMA. In Gerald’s standard formula the faster EMA is taken as 12 periods EMA and the slower EMA is taken as 26 periods EMA. The signal line is the EMA of MACD line itself; Gerald takes it as 9 periods EMA of the MACD line. Finally, the divergence or difference is the histogram, which is actually the difference between MACD line and signal line.
To be precise, the formulas are as follows:
• MACD Line: (12 Period EMA less 26 Period EMA)
• Signal Line: 9 Period EMA of MACD Line
• Histogram: MACD Line less Signal Line
Interpretation of MACD Line and Signal Line
The MACD and signal lines are plotted on a graph with (0,0) as its center line. In line with the name of this tool, whenever the EMAs, as plotted on the closing price chart converge or diverge, you will notice MACD line behaving in congruence to that. When MACD crossovers below or above the centre line, it means that the faster EMA has crossed the slower EMA. When the MACD is in positive, it means an upside momentum; the upside will increase the further faster EMA diverges from the slower one.
The signal line runs in congruence to the MACD line; its MACD line’s derivative. As it is MACD line’s moving average, it trails behind it. Whenever MACD line is above its signal line, it points to a bullish trend. Whereas a bearish crossover occurs when MACD line turns down and crosses below the signal line.