Moving Average Convergence-Divergence (MACD)

Introduction

Developed by Gerald Appel in the late seventies, Moving Average Convergence-Divergence (MACD) is one of the simplest and most effective momentum indicators available. The MACD indicator is basically a refinement of the two moving averages system and measures the distance between the two moving average lines. It 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, MACD offers the best of both worlds: trend following and momentum. MACD 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 MACD is unbounded, it is not particularly useful for identifying overbought and oversold levels.

Calculation

MACD: (12-day EMA - 26-day EMA)

Signal Line: 9-day EMA of MACD

MACD Histogram: MACD - Signal Line

Standard MACD is the 12-day Exponential Moving Average (EMA) less the 26-day EMA. Closing prices are used for these moving averages. A 9-day EMA of MACD is plotted along side to act as a signal line to identify turns in the indicator. The MACD -Histogram represents the difference between MACD and its 9-day EMA, the signal line. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

In the chart above, the black line (MACD) is the moving average of the difference between the 12 and 26-period moving averages. The red line (Signal Line) plots the average of the last 9 periods of the black line (MACD). This smoothens out the MACD even more, which gives us a more accurate line. The histogram simply plots the difference between the MACD and the Signal Line.

If you look at above chart, you can see that, as the MACD and the Signal Line separate, the histogram gets bigger. This is called divergence because the faster moving average is "diverging" or moving away from the slower moving average. As the moving averages get closer to each other, the histogram gets smaller. This is called convergence because the faster moving average is "converging" or getting closer to the slower moving average. Hence it got the name, Moving Average Convergence Divergence.