Technical Analysis Secrets #3:

Moving Average Convergence

Divergence

Simply put, the Moving Average Convergence Divergence (MACD) is a

trend-following momentum indicator. To calculate the MACD, the 26-
period exponential moving average (EMA) is subtracted from the 12-
period EMA, and if you want to read more about these MAs, check out my
previous couple of blog posts. As a result you get the MACD line (shown
as a blue line in the graph below). On top of the MACD line, the “signal
line” is plotted (shown as a yellow line on the graph) that is calculated as a
9-period EMA of the actual MACD.

The MACD and signal lines are then used as a technical trigger to either
buy the asset when the MACD line crosses above the signal line or to sell
the asset, when the MACD crosses below the signal line (also shown on
the graph below). In addition to crossovers, the MACD can be interpreted
in several ways, but the most common ones are crossovers, divergences
and rapid rises/falls.

The MACD can have a positive or a negative value. It’s positive when the
12-period EMA is above the 26-period EMA and negative if it’s below the
26-period EMA. Usually you’ll also see a baseline, which indicates the
value 0 for the MACD. Besides the MACD line, the signal line and the
baseline, there’s also a histogram which displays the distance of the
MACD line from the signal line. If the MACD is above the signal line, the
histogram will be plotted above the baseline, and if the MACD is below
the signal line, the histogram will be plotted blow the baseline. You can
check the MACD’s histogram to see if the bearish or bullish momentum is
high.
While MACD is a solid technical trigger, it is often used together with
other indicators or signals such as Relative Strength (RSI) and a 20-
period Simple Moving Average (SMA), because it has a few problems like
producing a false positive While MACD is a solid technical trigger, it
is often used together with other indicators or signals such as
Relative Strength (RSI) and a 20-period Simple Moving Average
(SMA), because it has a few problems like producing a false
positive signal for a reversal and not forecasting all reversals.

A false positive signal often occurs in two scenarios:

 when the price of an asset moves sideways (eg. in a range or

in a pattern), because the distance between the distance
between 26-period MA and the 12-period MA (which is
exactly what the MACD is measuring) narrows
 when the price of an asset is gapping higher and then
accelerates upwards, which causes the MACD to jump and
since the gapping can’t be sustained, a divergence occurs
despite the trend only slowing down instead of reversing

A few more tips for using the MACD indicator:

 always utilize price action (the ultimate indicator) together

with divergence (a momentum indicator that’s based on price
data)

 if a divergence occurs, don’t exit your trade just because of

the divergence as it does not always result in a reversal, so
always look for confirmation on other indicators, trendlines
etc.

 if you’re looking to enter a trade based on a divergence, wait

for the price to break the trend so that it confirms the
divergence

 expect to see divergence when the price movement slows or

moves sideways, but this isn’t always a reliable signal

signal for a reversal and not forecasting all reversals.

A false positive signal often occurs in two scenarios:

 when the price of an asset moves sideways (eg. in a range or in a

pattern), because the distance between the distance between 26-
 period MA and the 12-period MA (which is exactly what the MACD is
measuring) narrows

 when the price of an asset is gapping higher and then accelerates

upwards, which causes the MACD to jump and since the gapping can’t
be sustained, a divergence occurs despite the trend only slowing down
instead of reversing

A few more tips for using the MACD indicator:

 always utilize price action (the ultimate indicator) together with

divergence (a momentum indicator that’s based on price data)

 if a divergence occurs, don’t exit your trade just because of the

divergence as it does not always result in a reversal, so always look for
confirmation on other indicators, trendlines etc.

 if you’re looking to enter a trade based on a divergence, wait for the

price to break the trend so that it confirms the divergence

 expect to see divergence when the price movement slows or moves

sideways, but this isn’t always a reliable signal