Developed by Gerald Appel in the late seventies, the Moving Average Convergence/Divergence oscillator ( ) is one of the simplest and most effective momentum indicators available. The turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. As a result, the offers the best of both worlds: trend following and momentum. The fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, centerline crossovers and divergences to generate signals. Because the is unbounded, it is not particularly useful for identifying overbought and oversold levels.
Note: can be pronounced as either “Mac-Dee” or “M-A-C-D.”
Moving average convergence divergence ( ) is a trend-following that shows the relationship between two moving averages of prices. The is calculated by subtracting the 26-day ( ) from the 12-day . A nine-day of the , called the "signal line", is then plotted on top of the , functioning as a trigger for buy and sell signals.
BREAKING DOWN 'Moving Average Convergence Divergence - MACD'
Moving average convergence divergence ( ) indicators can be interpreted using three different methods:
1. Crossovers - As shown in the chart above, when the falls below the signal line, it is a signal, which indicates that it may be time to sell. Conversely, when the rises above the signal line, the indicator gives a signal, which suggests that the price of the asset is likely to experience upward momentum. Many traders wait for a confirmed cross above the signal line before entering into a position to avoid getting getting "faked out" or entering into a position too early, as shown by the first arrow.
2. Divergence - When the security price diverges from the , it signals the end of the current trend. For example, a stock price that is rising and a indicator that is falling could mean that the rally is about to end. Conversely, if a stock price is falling and the is rising, it could mean that a reversal could occur in the near-term. Traders often use divergence in conjunction with other technical indicators to find opportunities.
3. Dramatic Rise - When the rises dramatically - that is, the shorter moving average pulls away from the longer-term moving average - it is a signal that the security is overbought and will soon return to normal levels. Traders will often combine this analysis with the ( ) or other technical indicators to verify overbought or oversold conditions.
Traders also watch for a move above or below the zero line because this signals the position of the short-term average relative to the long-term average. When the is above zero, the short-term average is above the long-term average, which signals upward momentum. The opposite is true when the is below zero. As you can see from the chart above, the zero line often acts as an area of for the indicator.
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