Moving Average Convergence/Divergence
What is MACD (Moving Average Convergence/Divergence)?
The Moving Average Convergence/Divergence or MACD is a widely-used form of technical analysis. It’s a hybrid indicator, combining elements of both momentum and moving-average analysis to measure momentum in price movements. It comprises three lines: the MACD Line, the Centre Line, and the Signal Line. Analysis can also be extended to include a histogram.
- The MACD Line is the difference between two exponential moving averages plotted around a centre line.
- The Centreline is the point at which the two moving averages are equal.
- Along with MACD and the Centreline, the Signal Line tracks the exponential moving average of the MACD.
As a measurement, MACD compares short-term momentum to longer-term momentum, which can help signal the current direction of energy.
Calculation of the MACD Line and Signal Line
The two moving average values most commonly used in the calculation of the MACD Line are the 26- period and 12-period exponential moving averages. The Signal Line is sometimes built using a 9-period exponential moving average of the MACD Line.
These values can be adjusted to meet your individual needs and the specifics of different markets. For more volatile markets, shorter-term moving averages can be used, while less volatile securities should have longer moving averages. MACD can be an effective analysis tool across a number of different time frames.
Another aspect of the MACD indicator often found on charts is the MACD histogram (or Forest as some software programmes may refer to it). The histogram is plotted on the centre line and represented by bars. Each bar is the difference between the MACD and the Signal line.
The higher the bars are in either direction, the greater the distance between the MACD and Signal lines, which implies more significant momentum behind the direction towards which the bars point.
Reading the MACD and Signal Lines
When the MACD Line is positive (above the zero-neutral line) it signals that the shorter-term moving average (i.e. on a daily chart, the 12-day exponential moving average) is above the longer-term moving average (i.e. the 26-day exponential moving average).
When the nearer-term average price is higher than the longer-term average price, it suggests that the price momentum is getting stronger. Therefore, a positive MACD suggests the current price has upward momentum.
When the MACD is negative (below the zero line), it signals that the shorter-term is below the longer-term, which suggests that the current price has downside momentum.
As the two moving averages cross over each other, the MACD line will cross over the centre line. When this happens, it suggests that the MACD lines can be used to signal bullish or bearish trends depending upon their configuration.
In Figure 1 (above), the MACD and Signal lines are rising in early September 2019, but still below the zero line. This could mean that the market rebound is still just a bear market recovery. However, as the trend strengthens, the shorter moving average crosses above the longer moving average and the MACD Line pushes above neutral into positive territory above zero. This now implies a strengthening outlook for the price. Once the Signal line also moves into positive territory, the trend is considered to be bullish.
Trading with MACD
Crossovers and Kisses
The Signal Line can also be used to generate trading signals. Being an exponential moving average of the MACD Line, the Signal Line will naturally lag behind the MACD. However, when the MACD Line begins to converge back towards the Signal Line, you can start to see trading signals. It’s at that point you should look for a “Crossover” or a “Kiss”.
When the MACD Line crosses over the lagging Signal Line, this indicates a reversal in the trend.
- A “bull cross” is where the MACD Line crosses back above the Signal Line.
- A “bear cross” is where the MACD line drops below the Signal Line. These are both reversal signals.
However, if the two lines converge and “kiss” before moving back in the original direction, this can also be a powerful continuation signal.
- A “bull kiss” is a positive continuation in an uptrend.
- A “bear kiss” is a negative continuation signal in a downtrend.
Figure 2: MACD crossovers and kisses on GBP/USD
Technical analysts would look for divergences in either the lines or the histogram. These are an early indication of slowing of the strength of the trend (in either direction).
In Figure 3 below, the MACD lines post a second higher bull cross buy signal for EUR/USD in late December 2016. This is a bullish divergence as the price has continued to fall. Note how the MACD histogram also exhibits a bullish divergence with the price. These positive signals mark the long-term low.
Figure 3: MACD bullish divergences on Euro/Dollar