The Moving Average Convergence Divergence (MACD) indicator was created in the 1960s by Gerald Appel and was designed to follow momentum and display any trend changes that may occur. A MACD chart consists of plotting two lines: the MACD Line and the signal line. The MACD line is created by using this formula EMA(26) – EMA(12), where EMA(26) and EMA(12) are the 26 and 12 day exponential moving averages. The Signal Line is simply the EMA(9), or 9 day exponential moving average. You may also find a solid block histogram on the chart which represents the difference between the two lines, and is calculated by subtracting the signal line from the MACD line (MACD-EMA(9)).

When looking at a MACD chart, you will be looking for 3 different types of indicators; a crossover between the MACD line and the signal line, the MACD line crossing over the zero point, and the MACD Line and Price moving in opposite directions which is known as Divergence.

The Crossover is the signal that is most commonly used, and is the signal that I use for my technical analysis. A BUY signal occurs when the MACD line starts off being below the signal line and then crosses over to be above the signal line. This shows that a change in momentum direction has occurred and it is a good time to buy the stock. A Sell signal occurs in the exact opposite of situations, when the MACD line starts off being above the signal line and then crosses over to be below the signal line. Often it may look like a crossover is going to happen but it will change directions again right before it takes place, so it is a good idea to wait for the actual crossover to take place or have confirmation from other indicators before preemptively initiating any trades.

When the MACD line crosses over the zero point, this is an indication of either a bullish (if the line goes from below to above) or bearish (if the line goes from above to below) trend. The zero line marks the point where the EMA(26) and EMA(12) would cross paths if they were plotted on a graph because of this, the zero line will often be seen as a point of support or resistance in the price movement. Another way to look at this, is if the MACD line is above zero then the price is overbought compared to the long term (26 day) average, where as if it is below the zero line, then the price is oversold compared to the long term (26 day) average.

If Divergence occurs between the MACD direction and the current price direction then this is usually a sign that the current trend is about to change. This is important to keep an eye on because it gives you an idea that a change might be happening. One example of this is if the price makes a new high but the MACD line fails to make a new high then you are likely going to see a reversal happening soon.

So putting this all together, what do we have? To answer this, let us take a brief look at how I use the MACD indicator when analyzing a stocks chart. First and foremost, I take a look at a the chart on a weekly scale, this gives me an idea of the long term trend of the stock, if this trend looks favourable (in an upward direction) then I will go to the daily chart for the real analysis. On the daily chart I will first look for a buy signal from the Slow Stochastic indicator (I will explain this indicator in another post), which will generally occur first before a MACD buy signal. Then I look to the MACD chart and look for the MACD line to be BELOW the zero line, if this happens, then I will watch the stock until I get a crossover in the form of the MACD line moving above the signal line. This crossover has to happen within a 'few' days of the slow stochastic buy signal otherwise I will not take action. I plan on explaining my strategy in full in a post to come. Know that what I look for in my analysis is always evolving, but to this day, the MACD indicator has always been an important part of my analysis. It is worthwhile to note that the MACD is a market lagging indicator, which means that in highly volatile market conditions it may not be the best indicator to use. Personally I would not recommend the MACD indicator be used by itself; I find that it is best used in conjunction with other indicators like the slow stochastic for example.

I hope that I have given you a good idea of how the MACD Indicator works as well as how I use it in my analysis. Even though it has fallen out of favour in recent years, I have continued to achieve a good amount of success in having it incorporated into my strategy. Happy trading!

Disclaimer: Technical Analysis is speculative by nature and cannot be relied on as a 'sure thing'. Always do your own research and seek professional advice before initiating any trades. I am not a professional and my writing should not be taken as advice. I do not give any guarantee of success or failure through the use of this technical indicator.