Lesson 8 – MACD

Written on 10 November 2008 by Rod

Moving Average Convergence / Divergence (MACD)

Moving Average Convergence-Divergence also known as MACD was developed by a man named Gerald Appel.

Mr Appel was an analyst in New York and he originally designed the MACD for the analysis of stock trends. Today MACD is being used widely in many markets including Forex.

The MACD is an oscillator lagging indicator, meaning it walks behind prices, because it is based on the moving average indicator. However, the MACD is more sensitive to price movements.

The MACD indicator consists of two lines; the first line in the MACD is the MACD line, and it commonly uses the 12 period exponential moving average of the price, also known as the fast EMA. To this, subtract an exponential moving average of the price usually a 26 period EMA, also known as the slow EMA and you get the following equation:

MACD = 12 EMA of price – 26 EMA of price

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

It is important to note that these EMAS may be applied to the following prices:
close price
open price
high price
low price
median price ((high + low) /2)
typical price ((high + low + close)/3)
weighted close price ((high + low + close + close)/4)

However, the most common type of price used for the MACD is the closing price.

The second line is called the “Signal line” and it usually uses a 9 period simple moving average of the previous line (MACD line), giving us the following equation.

Signal = MACD – 9 SMA of MACD

Configuring the MACD:

The typical recommended settings for MACD is 26 EMA for the slow moving average, 12 EMA for the fast moving average and 9 SMA for the signal line.

However, these settings are the ones used commonly and as default in trading stations like MetaTrader 4, but you may choose the settings that fit your trading strategy and time frames.

The shorter moving averages will produce quicker signals that are more sensitive to the price movements while the slower moving averages will produce slower signals that could be more accurate, but you will receive a lot less signals.

How to use the MACD indicator for trading?

The MACD indicator is used to forecast market movements. MACD can be used in different ways, but the most used methods are:

• Crossing of moving averages
• Cross of the Centerline
• Divergence

Crossing of Moving Averages:

When the MACD crosses above the 9 period simple moving average, a bullish signal occurs.

Conversely, when the MACD crosses under the 9 period simple moving average a bearish signal occurs .

Once again, it is important to note that this strategy alone may produce a lot false signal and must be confirmed with other indicators.

Cross of the Centerline:

When the MACD crosses above or over the zero line (Centerline) a bullish signal occurs.

Conversely, when the MACD crosses under the zero line a bearish signal occurs.

Like the Moving average crossing signals, these signals must be confirmed by other technical or fundamental indicators.

Divergence:

Divergence ocurres when the Price makes a new high while the MACD fails to do so in case of a bullish markets and when prices make a new low and MACD fails to do so in case of a bearish market.

Note how prices make new highs but the MACD shows a debilitating uptrending market due to the fact that the it cannot keep up ith the new highs. We see a fall in prices right after this signal.

On the contrary, a bearish signal occures when the MACD makes a new Low, but the market price does not.

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