The MACD indicator (Moving Average Convergence Divergence) is a momentum and trend-following indicator. It 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, but it is not typically used to identify overbought or oversold conditions. The MACD appears on the chart as two lines that oscillate without boundaries.
FAQ on Moving Average Convergence Divergence
Many traders say Moving Average Convergence Divergence is the father of all indicators. Which is abbreviated as MACD or as the father of indicators many people call it as MAC-Daddy. The MACD indicator strategy was developed by Gerald Appel, publisher of Systems and Forecasts. It is a Trend following momentum indicator. It shows the relationship between two moving averages of prices. MACD is the difference between a 26-day exponential MA and 12 days EMA. Finally, a 9-day EMA, called signal line is plotted on top of MACD to show buy/ sell opportunities.
We can calculate MACD 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.
MACD indicator strategy / MACD formula helps one to understand the immediate direction of the underlying. The MACD above the zero line is bullish while below the zero line, it is bearish. There is another way to read the Moving Average Convergence Divergence. When the MACD crosses the signal it is a buy signal. On the other hand, when it crosses below the signal line it is a sell signal.
There are three popular ways to use MACD – Crossover, overbought/ oversold condition, and divergence. MACD proves most effective in a wide-swinging market. The signal shows effectively when to take a buy position and when to take a sell position.
How to Attach Moving Average Convergence Divergence to a Chart?
MACD Indicator on Zerodha Kite
We can easily attach the indicator to a Zerodha Kite from the STUDIES section. Watch the image below to check how we attached the indicator on the HDFC share price chart. By default, the parameters are 12-26-9, but you can test other versions of MACD like 3-10-16 as described by Corey Rosenbloom in his 3-10 oscillator, etc.
MACD Indicator on Upstox Pro
The MACD indicator is also available on the Upstox Pro platform. All terminals use almost the same kind of parameters for this indicator.
MACD Indicator for MT4
In Metatrader or MT4 platform, the Moving Average Convergence Divergence is available in a different form. Here the histogram is very powerful. To attach the indicator on MT4 you need to open the indicators tree. Inside the indicators tree, there is a subgroup of Oscillators. Inside this, you will get MACD. Double-click on it to select the parameters and attach the indicator on the charts.
How to use MACD Indicator?
Moving Average Convergence Divergence generates the following trading signals. Traders worldwide use these trading signals.
Moving Average Crossover in Moving Average Convergence Divergence
This is the most important signal of the moving average convergence divergence is when the faster MA (Moving Average) breaks the slower one. Therefore, traders often use this signal to enter new trades.
A basic trading rule is that sell the stock when the MACD falls below its signal line. Similarly one also buys the stock when MACD rises above the signal line. Another popular method is that a trader buys when MACD goes above zero and sells when MACD goes below zero.
Divergence Trading with Moving Average Convergence Divergence
Moving Average Convergence Divergence also gives signals for divergence. For example, if a trader sees the price increasing and the indicator recording lower tops or bottoms, then traders 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.
An indication that the current trend is going to end and a reversal may take place occurs when the MACD diverges from the stock price. Or we can say it when the MACD pulls away from the trend shown by the price of the security. A bearish divergence occurs when MACD makes new lows and the stock price fails to make new lows. A bullish divergence occurs when MACD makes new highs but the price doesn’t. These divergences are more significant when they occur at relatively overbought/ oversold levels.
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.
Overbought/ Oversold conditions in Moving Average Convergence Divergence
When the shorter exponential moving average pulls away from the longer moving average, i.e. the MACD rises, it is very likely that the security is overextending its position and will soon return to more realistic levels. This overbought/ oversold condition varies from security to security.
The histogram was developed by Tomas Asprey in 1986. It measures the distance between the MACD and its signal line. Asprey developed the histogram to anticipate signal line crossovers of the MACD. Traders consider the histogram moving above or below zero as bullish or bearish. Many traders consider security bullish or bearish only depending on the MACD histogram. The MACD histogram is very prominent in the MetaTrader platform.
MACD Indicator PDF and Suggested Reading
There are many PDF ebooks or Kindle books on the Moving Average Convergence Divergence. You can read the following: MACD/Divergence Trading: How to Build a Profitable Trading System Using Moving Average Convergence-Divergence.
I also do suggest a special video course on this subject. The name of the course is The MACD Paycheck: Simple Trading Laws for Extraordinary Wealth (Wiley Trading Video). This course has been designed by Dale Wheatley. Most importantly, he has earned heavy profits by using this MACD indicator only.
Moving Average Convergence Divergence or the MACD indicator is one of the basic indicators. Anyone interested in technical analysis should know the usage of this indicator. We can use this indicator in various ways. The basic trading signal is a crossover of moving averages. Other signals are the overbought oversold conditions or divergence. In conclusion, the MACD indicator strategy works best if we combine it with some other indicators. A combined study with a few other indicators makes trading more successful.