Moving Averages Crossover Masterclass Part 1

Moving Average Convergence Divergence (MACD)

• Created by Gerald Appel
  
• It was designed in order to reveal changes in the direction, strength, momentum, and duration of a trend in a stock’s price
  
• It is a trend-following momentum indicator which shows the relationship between two moving averages of a stock’s price
  
• As the name suggests, MACD is all about the convergence and divergence of two moving averages
  
• Convergence occurs when the moving averages move towards each other while Divergence occurs when the moving averages move away from each other
  
• Three main components of MACD Calculation: MACD line, Signal line, and MACD Histogram
  

MACD line – Calculated by subtracting 26-day EMA (Exponential Moving Average) from 12-day EMA.

Exponential Moving Average (EMA) is a type of moving average which places a greater weightage on the recent data points when compared to the past data points, making it react more significantly than a simple moving average.

Signal line – 9-day EMA of the MACD line is called the signal line

Histogram – Histogram is the graphical distance between MACD and the signal line, height used to assess how strong the price is moving in the given direction

There are three main parameters of MACD as a whole:

• Look-back period of long term EMA to be formulated for MACD
  
• Look-back period of short term EMA to be formulated for MACD
  
• Look-back period of EMA to be formulated for signal line calculation
  

There are many ways MACD can be used to formulate trading strategy, out of which we will be discussing two in this post:
1. Centerline Crossover

• Centerline: Zero lines above and below which the MACD line oscillates, diving the canvas in bullish and bearish regions
  
  
• Bullish Crossover when MACD line moves above zero i.e. 12-EMA crosses up 26-EMA
  
• Bearish Crossover when MACD line moves below zero i.e. 12-EMA crosses down 26-EMA
  
  Signal Generation
  
• BUY when MACD crosses up 0 while SELL when MACD crosses down 0
  

2. Signal line crossover

• The signal line is 9-day EMA of MACD that means it trails the MACD thereby indicating momentum changes in convergence-divergence
  
  
• Bullish crossover when MACD turns up and crosses above the signal line
  
• Bearish crossover when MACD turns down and crosses below the signal line
  
  Signal Generation
  
• BUY when MACD crosses up the signal line and SELL when MACD crosses down the signal line
  

A lot more interesting things can be done using MACD, about which we'll be talking in the next Masterclass on MACD.
STAY TUNED!
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