The MACD indicator (Moving Average Convergence Divergence) is a momentum and trend-following indicator that is based on the information of moving averages. It is developed by Gerald Appel in the late seventies. The MACD oscillator is one of the simplest and most effective momentum indicators available. The Moving Average Convergence/Divergence (MACD) indicator is a momentum oscillator primarily used to trade trends. It is also an oscillator, it is not typically used to identify overbought or oversold conditions. The MACD appears on the chart as two lines which oscillate without boundaries.
The indicator can be easily attached to a chart in Zerodha Kite from the STUDIES section. Watch the image above to check how the indicator is attached on HDFC share price chart. By default the parameters are 12-26-9, but you can test other versions of MACD like 3-1016 as described by Corey Rosenbloom in his 3-10 oscillator etc.
MACD Indicator Calculation
MACD can be calculated by subtracting the value of a 26 period EMA (Exponential Moving Average) from a 12 period EMA. The shorter EMA (Exponential Moving Average) is constantly converging toward, and diverging away from the longer EMA. The signal line is created with a 9 period EMA (Exponential Moving Average) of the MACD line.
These signals are provided by the MACD indicator:
- Moving Average cross –
This is the most important signal of the moving average convergence divergence is when the faster MA (Moving Average) breaks the slower one. In the traders often use this signal to enter new trades.
- Divergence –
MACD (Moving Average Convergence Divergence) also gives divergence signals. For example, if a trader sees the price increasing and the indicator recording lower tops or bottoms, then trader have a bearish divergence. The trader has a bullish divergence when the price drops and the moving average convergence divergence produces higher tops or bottoms.
- Distance between MAs (overbought/oversold) –
The MACD indicator has no limit. So, many traders do not think of using the tool as an overbought/oversold indicator. When a stock has entered an overbought/oversold territory, then a large distance between the fast and slow lines of the indicator. The easiest way to identify this divergence is by looking at the height of the histograms on the chart. In this indicator, this divergence often leads to sharp rallies counter to the primary trend. These signals are visible on the chart as the cross made by the fast line will look like a teacup formation on the indicator.