What’s MACD?

The Moving Average Convergence/Divergence (MACD) is a trend-following momentum indicator that shows the
relationship between two 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 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.

Key takeaways:

 MACD is a trend-following momentum indicator that shows the relationship between the moving averages of
a security’s price.
 MACD is best used with daily periods, where the traditional settings of 26/12/9 day is the default.
 MACD triggers technical signals when the MACD line crosses above the signal line or falls below it.
 MACD can help gauge whether a security is overbought or oversold, alerting traders to the strength of a
directional move, and warning of a potential price reversal.
 MACD can also alert investor to bullish/bearish divergences (Prices makes new highs or lows but MACD does
not).
 After a signal line crossover, it is recommended to wait for three or four days to confirm that it is not a false
move.

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 EMA12 is below the EMA26. 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 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 it’s 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/sold signals.

MACD vs RSI:

The RSI aims to signal whether a market is considered to be overbought or oversold in relation to recent price levels.
The RSI is an oscillator that calculates average price gains and losses over a given period of time. The default time
period is 14, with values bounded from 0 to 100. A reading above 70 suggests an overbought condition, while a
reading below 30 is considered oversold, with both potentially signaling a top is forming, or a bottom.

The MACD lines, however, do not have concrete overbought/oversold levels like the RSI. Rather, they function on a
relative basis. That’s to say an investor should focus on the level and direction of the MACD/signal lines compared
with preceding prices movements in the security at hand, as shown below.
MACD measures the relationship between two EMAs, while the RSI measures price change in relation to recent price
highs and lows. These two indicators are often used together to give analysts a more complete technical picture of a
market.

These indicators both measure momentum in a market, but because they measure different factors, they sometimes
give contrary indications. For example, the RSI may show a reading above 70 for a sustained period of time, indicating
a market is overextended to the buy side in relation to recent prices, while the MACD indicates that the market is still
increasing in buying momentum.

Either indicator may signal an upcoming trend change by showing divergence from price (price continues higher
while the indicator turns lower, or vice versa).

Limitations of MACD and confirmation:

One of the main problems with a move average divergence is that is can often signal a possible reversal, but then
nothing 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, such at the Direction Movement Index
(DMI) system, and its key component, the Average Directional Index (ADX). The ADX is designed to indicate whether a
trend is in place or not, with a reading above 25 indicating a trend is in place, and a reading below 20 suggesting no
trend is in place.

Investors following MACD crossovers and divergences should double-check with the ADX before making a trade on a
MACD signal. For example, while MACD may be showing a bearish divergence, a check of the ADX may tell you that a
trend higher is in place – in which case you would avoid the bearish MACD trade signal and wait to see how the
market develops over the next few days.

On the other hand, if MACD is showing a bearish crossover and the ADX is in non-trending territory and has likely
shown a peak and reversal on its own, you could have good cause to take the bearish trade.

Furthermore, false positive divergence often occur when the price of an asset moves sideways in a consolidation,
such as in a range or triangle pattern following a trend. A slowdown in the momentum – sideways movement or slow
trending movement – of the price will cause MACD to pull away from its prior extremes and gravitate toward the zero
lines even in the absence of a true reversal. Again, double check the ADX (or Ichimoku/RSI/Stoch) to determine
whether a trend is in place and also look at what price is doing before acting.
Example of MACD crossovers:

As shown on the following chart, when MACD falls below the signal line, it is a bearish signal indicating that it may be
time to sell. Conversely, when MACD rises above the signal line, the signal is bullish, suggesting that the price of the
asset might experience upward momentum. Some traders wait for a confirmed cross above the signal line before
entering a position to reduce the chances of being faked out and entering a position too early.

Crossovers are more reliable when they conform to the prevailing trend. If MACD crosses above its signal line after a
brief downside correction within a longer-term uptrend, it qualifies as a bullish confirmation and the likely
continuation of the uptrend.

If MACD crosses below its signal line following a brief move higher within a longer-term downtrend, traders would
consider that a bearish confirmation.
Example of divergence:

When MACD forms highs or lows that exceed the corresponding highs and lows on the price, it is called a divergence.
A bullish divergence appears when MACD forms two rising lows that correspond with two falling lows on the price.
This is a valid bullish signal when the long-term trend is still positive.

Some traders will look for bullish divergences even when the long-term trend is negative because they can signal a
change in the trend, although this technique is less reliable.

When MACD forms a series of two falling highs that correspond with two rising highs on the price, a bearish
divergence has been formed. A bearish divergence that appears during a long-term bearish trend is considered
confirmation that the trend is likely to continue.

Some traders will watch for bearish divergences during long-term bullish trends because they can signal weakness in
the trend. However, it is not as reliable as a bearish divergence during a bearish trend.
Example of rapid rises or falls:

When MACD rises or falls rapidly (the shorter-term moving average pulls away from the longer-term moving
average), it is a signal that the security is overbought or oversold and will soon return to normal levels. Traders will
often combine this analysis with the RSI or other technical indicators to verify overbought or oversold conditions.

It is

not uncommon for investors to use the MACD’s histogram the same way that they may use the MACD itself. Positive
or negative crossovers, divergences, and rapid rises or falls can be identified on the histogram as well. Some
experience is needed before deciding which is best in any given situation, because there are timing differences
between signals on the MACD and its histogram.

How do traders use MACD?

Traders use MACD to identify changes in the direction or strength of a stock’s price trend. MACD can seem
complicated at first glance because it relies on additional statistical concepts such as the EMA. But fundamentally,
MACD helps traders detect when the recent momentum in a stock’s price may signal a change in its underlying trend.
This can help traders decide when to enter, add to, or exit a position.

Is MACD a leading indicator or a lagging indicator?

MACD is a lagging indicator. After all, all the data used in MACD is based on the historical price action of the stock.
Because it is based on historical data, it must necessarily lag the price. However, some traders use MACD histograms
to predict when a change in trend will occur. For these traders, this aspect of MACD might be viewed as a leading
indicator of future trend changes.

The bottom line:

MACD is a valuable tool of the moving-average type, best used with daily data. Just as a crossover of the nine (and
14) day SMAs may generate a trading signal for some traders, a crossover of the MACD above of below its signal line
may also generate a directional signal.

MACD is based on EMAs (more weight is placed on the most recent data), which means that it can react very quickly
to changes of direction in the current price move. But that quickness can also be a two-edged sword. Crossovers of
MACD lines should be noted, but confirmation should be sought from other technical signals, such as the RSI, or
perhaps a few candlestick price charts. Further, because it is a lagging indicator, it argues that confirmation in
subsequent price action should develop before taking the signal.