Moving average convergence/divergence (MACD, or MAC-D) is a trend following momentum indicator that shows the relationship between two exponential moving averages (EMAs) of a security’s price. The MACD line is calculated by subtracting the 26-period EMA from the 12-period EMA.
The result of that calculation is the MACD line. A nine-day EMA of the MACD line is called the signal line, which is then plotted on top of the MACD line, which can function as a trigger for buy or sell signals. Traders may buy the security when the MACD line crosses above the signal line and sell-or short-the security when the MACD line crosses below the signal line. MACD indicators can be interpreted in several ways, but the more common methods are crossovers, divergences, and rapid rises/falls.
Learning from MACD
MACD has a positive value (shown as the blue line in the lower chart) whenever the 12-period EMA (indicated by the red line on the price chart) is above the 26-period EMA (the blue line in the price chart) and a negative value when the 12-period EMA is below the 26-period EMA. The level of distance that MACD is above or below its baseline indicates that the distance between the two EMAs is growing.
In the following chart, you can see how the two EMAs applied to the price chart correspond to the MACD (blue) crossing above or below its baseline (red dashed) in the indicator below the price chart.
MACD is often displayed with a histogram (see the chart below) that graphs the distance between MACD and its signal line. If MACD is above the signal line, the histogram will be above the MACD’s baseline, or zero line. If MACD is below its signal line, the histogram will be below the MACD’s baseline. Traders use the MACD’s histogram to identify when bullish or bearish momentum is high-and possibly for overbought/oversold signals.
MACD Formula
MACD = 12-Period EMA - 26-Period EMA
MACD is calculated by subtracting the long-term EMA (26 periods) from the short-term EMA (12 periods). An EMA is a type of moving average (MA) that places a greater weight and significance on the most recent data points.
The exponential moving average (EMA) is also referred to as the exponentially weighted moving average. An exponentially weighted moving average reacts more significantly to recent price changes than a simple moving average (SMA), which applies an equal weight to all observations in the period.
Limitations of MACD and Confirmation
One of the main problems with a moving average divergence is that it can often signal a possible reversal, but then no actual reversal happens-it produces a false positive. The other problem is that divergence doesn’t forecast all reversals. In other words, it predicts too many reversals that don’t occur and not enough real price reversals. This suggests confirmation should be sought by trend-following indicators.
Source: Investopedia, MACD Indicator Explained, with Formula, Examples, and Limitations, accessed 27 December 2023, <https://www.investopedia.com/terms/m/macd.asp>