Successful investing requires the ability to track trends with a series of indicators. One indicator to analyze trends and momentum over time is the moving average convergence divergence, or MACD. What is MACD exactly, and what does it indicate for market conditions? We’ll take a look at the MACD meaning and how to interpret it below.
What is MACD?
MACD stands for moving average convergence divergence, a momentum indicator that tracks a security’s price changes over time. It’s considered a lagging indicator, because it relies on historic data including average price movements.
When looking at a MACD chart you’ll see a trendline following the relationship between a security price’s two moving averages. To calculate the MACD, you subtract a 26-period exponential moving average, or EMA, from the 12-period EMA. After subtracting the 26-period EMA from the 12-period EMA to arrive at MACD, analysts plot this on a graph. They can then plot an additional nine-day EMA of the MACD over the MACD line. This top line is called the signal line, and investors look at all of these plot points together to determine whether to buy or sell.
As a result, MACD usually appears as two lines on a chart, crossing over one another to give trading signals. There’s also a histogram which shows the difference in value between the signal line and MACD line.
This type of indicator is designed to measure a security’s price momentum or the strength of a trend. There are many techniques used when determining how to read MACD, including tracking whether the line goes above or below its signal line. You can also look at additional factors including rapid rises or falls in value, divergences, and crossovers. Typically, when the MACD goes above its signal line this means it’s time to buy the security. When the MACD goes below the signal line, this indicates it’s time to sell.
How to read MACD
Here are a few basic factors to keep in mind when looking at how to read MACD charts.
When the MACD line goes above zero, this signals a market uptrend or bull market.
When the MACD line goes below zero, this indicates a downtrend or bear market.
When the MACD dips up from below zero it’s bullish.
When the MACD turns down from above zero it’s bearish.
When the MACD line crosses above the signal line, it’s time to buy.
When the MACD line crosses below the signal line, it’s time to sell.
It’s not uncommon for the MACD to wildly oscillate back and forth across the zero and signal lines, which makes drawing conclusions less clear. Generally, investors are advised to avoid trading until this market volatility starts to stabilize.
Another common scenario is positive divergence, when the MACD doesn’t reach a new low in accordance with the security’s low. This is considered a bullish signal. The opposite scenario is negative divergence, when the MACD fails to reach the same new high as the stock price.
While MACD relies on some complicated statistical concepts like exponential moving average, most trading platforms will automatically generate charts to make the process easier.
Limitations of MACD
With MACD explained, you can see it’s certainly useful for traders and analysts alike. However, this type of indicator does come with limitations. It works best when a market is trending, rather than consolidating. In some cases, divergence can signal that a market reversal is on the horizon, but this never materializes. At the same time, when asset prices move sideways in a triangle pattern this can cause the MACD to trend closer to zero.
It’s also easy to misinterpret the results if you don’t have a solid understanding of basic moving averages already. For all these reasons, it’s best to use the MACD indicator along with other types of analysis to form a more informed view of market fluctuations.
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