MACD – Moving Average Convergence Divergence
MACD – Best Of Both Worlds – Trend and Momentum
One of the most popular indicator tools out there is the MACD, or simply pronounced ‘Mac-Dee’. It was developed in the late 70’s by Gerald Appel, perhaps people love the technical indicator because of it’s simplicity or the fact that it attempts to combine the best of both worlds of momentum and trend following. The elements of the MACD is the MACD line, Signal line and the histogram.
What is the MACD?
The MACD indicator turns two moving averages into a momentum oscillator by subtracting the longer moving average from the shorter period moving average. This gives a smoothed out line that is sort of an average of 2 averages.
The MACD itself is calculated usually using 12 day EMA – the 26 day EMA, this is seen as the red line in the chart above. You will also notice something called the ‘signal line’ which is seen in blue. This is calculated as a 9 day EMA of the MACD itself. The blue and red line is what is usually determines entry and exit signals.
The values used above are not set in stone, you can change them around to see what suits your style – they are however default values most charting programs start with.
The MACD histogram is the difference between the MACD and the Signal line.
Real World Use Case
MACD and Signal line Cross Over
One way to use the MACD is to sell when the blue line crosses the red line downwards, this indicates a loss of momentum and selling pressure based on the EMA averages. Here is an example of the DLF hourly chart with the crossover signals.
Centre Line Cross Over
The MACD is an oscillator and has a centre point of ‘0’ around which the MACD Signal line oscillate. The point of 0 determines an important balance of the stock prices. Since the MACD is made up of essentially averages we can use the centre point of 0 to determine whether the bulls are in control or the bears. To avoid unnecessary signals, make sure both the signal and the MACD cross the mid point 0 to determine bullish or bearishness.
As you can see in this time period, the efficiency of the signals do not correlate to very early entry points. The buy signals are marked with green arrows and sell signals with red signals, they trigger when both the MACD line and Signal line cross from over 0 to under zero for a sell. A buy is seen when both the MACD and Signal line cross from -1 to over 0. The mid point of 0 is used as the center point.
Notice that the entries are very late and lag quite a bit, also it may be difficult to determine the crossover sometimes as the movement is very less and barely above/below the 0 line. This is a common problem among many signal indicators. The solution is usually to wait for bars to close and then take action in which case we get a proper signal.
Mechanically trading the MACD crossover will produce losses when trading in a sideways market, this system seems to only work in very well trending markets. If that is the case why not trade something more simpler?
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