MACD

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MACD (Moving Average Convergence Divergence) was developed by Gerald Appel at 1981, and from this day it became one of the most used technical analysis indicators in the financial world.

The MACD based on the moving average which is a lagging indicator (walking behind the price) but the MACD is more sensitive for the price movements.

Note: there are three types of indicators, lagging…

The MACD indicator consists of two lines; the first line in the traditional MACD is the MACD line, and it uses the 12 period exponential moving average of the price (fast EMA) minus 26 period exponential moving average of the price (slow EMA).

MACD = EMA [12] of price – EMA [26] of price

The produced line oscillates around a zero line (Center Line) without upper and lower limits.

Note: You can apply the 12 EMA and 26 EMA to the close price, open price, high price, low price, median price ((high + low) /2), typical price ((high + low + close)/3) and weighted close price ((high + low + close + close)/4). The recommended and widely used price type is the close price.

The second line called the Signal line and it uses 9 period simple moving average of the previous line (MACD line).

Signal = MACD – SMA [9] of MACD

Figure 1 – Shows the MACD line (The red histogram) oscillates around zero centered line. And the Signal line (yellow line).

MACD settings:

The author of the MACD indicator recommends the default settings; 26 EMA for the slow moving average, 12 EMA for the fast moving average and 9 SMA for the signal line.

But you can choose the settings that fit your trade style, bear in your mind that shorter moving averages will produce quicker indicator that is more sensitive to the price movements while the slower moving averages will produce slower indicator that is less zigzagged (Figure 2 and 3).

How to use the MACD indicator for trading?

The MACD indicator is Bullish and Bearish signals generator that used to forecast the market movement.
It can be used in different ways, the most used methods of MACD trading are:

1- Moving average crossing

2- Centerline crossing.

3- Divergence.

Moving average crossing:

When the MACD crosses over upward (down to up) the 9 period simple moving average a Bullish signal occurs.
Conversely, when the MACD crosses over upward (down to up) the 9 period simple moving average a Bearish signal occurs (Figure 4).

Note: These signals usually false signal and must be confirmed with other indicators signals.

Centerline crossing:

When the MACD crosses over upward (down to up) the zero line (Centerline) a Bullish signal occurs.
Conversely, when the MACD crosses over upward (down to up) the zero line a Bearish signal occurs (Figure 5) .
Like the Moving average crossing signals these signals must be confirmed by other MACD signals (Divergence for example) or indicators signals.

Divergence:

When the MACD divergence from the market trend, it divergence from the trend when the MACD makes a new high while the trend failed to reach this high in the case it’s a Bullish signal.
Conversely, the Bearish signal occurs when the MACD makes a new low while the trend failed to reach this low.

Note: The MACD indicator can be used too as overbought/oversold indicator when the 12 period moving average (fast EMA) had been crossed the 26 period moving average (slow EMA) and pulls away for far distance and a long period, that’s usually a sign of overbought/oversold signal and the market near to reverse its direction.

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