MACD is a popular technical indicator that was developed by Gerald Appel in the 1970s. It is used to indicate changes in the momentum, direction and duration of an underlying asset’s price action. MACD focuses on the relationship between two moving averages. The first is called MACD line; it is calculated by subtracting the 26 period EMA (exponential moving average), from the 12 period EMA. The second line is known as the signal line, this is a 9 period EMA of the MACD line. Both the MACD line and the signal line are plotted over current price action, and the difference between them is presented in a histogram beneath the chart being monitored.
MACD works best in trending markets as its main strength is alerting traders to subtle changes in the strength and direction of an asset’s trend. There are three main things MACD traders look out for when using this technical indicator.
1. MACD/signal line crossovers: When the MACD line crosses up through the signal line it is a bullish signal indicating the emergence of an uptrend. When the MACD line crosses down through the signal line it is a bearish signal indicating that a downtrend is in effect. These crossovers are also clearly visible in the histogram, which shows the difference between the two. The point at which they cross over the histogram is to be found at zero because there is no difference between them.
2. MACD/Zero line crossovers: When the MACD line plotted on the histogram crosses the x-axis, or zero line there is no difference between the fast (short period) and slow (long period) EMAs that compose it. An upward move through the zero-line means that the short term EMA is above the long-term EMA, which is considered an indication of a possible bullish reversal, a downward move through the zero-line means that the long-term EMA is above the short-term EMA, which is considered an indication of a possible bearish reversal. It is important to keep in mind that while a zero crossover indicates a trend reversal, it says less about the momentum of this change than a signal-line crossover.
3. When the underlying asset’s price begins to diverge from the MACD line or histogram, i.e. price action moves either above or below the MACD line or histogram, this can be an indication that a current trend is beginning to break down.