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An Introduction to MACD

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An Introduction to MACD

Uploaded by

Sunil Jadhav
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© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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An Introduction to MACD

By Dennis G. Cajigas ISSUE 806 | June 2009

Moving Average Convergence/Divergence, otherwise known as MACD, was created by Gerald


Appel in the 1960s as a way to analyze market momentum and strength. While it fell out of favor
in the early 1980s, it experienced a resurgence of popularity with the development of the MACD
histogram by Thomas Aspey in 1986. The histogram provided a way to anticipate crossovers in
the MACD, providing another method of analysis that gave the MACD a renewed sense of
relevance. Traders often use the histogram as a tool to anticipate trend and momentum shifts.

One of the most useful things about the MACD is that it allows traders the ability to identify
market trend changes and strength of momentum in a single indicator. It is particularly popular
among currency traders.

The MACD represents the difference between two (fast and slow) weighted moving averages of
closing prices. A trigger line, or signal line, is created by smoothing the result with another
weighted moving average. The centered momentum oscillator indicates shifts in trend or changes
in momentum.

Common Pitfalls

The MACD is a powerful and useful indicator, but it is a lagging indicator. Often there may be a
delay between a signal in the MACD and price movement. The MACD may be used in all
market condition types, but it is most useful in volatile markets when trends change more
frequently.

Traders should be careful not to mix signals when forming their trade strategies. For example,
when entering a momentum-based trade, the exit strategy should be on a momentum indicator
rather than a price, time or profit target.

Four Types of Signals

1. Moving Average Crossover. This occurs when the two moving averages (fast and slow) cross.
It indicates a potential shift in trend. It is the most common type of signal, but should be
reinforced with another type of signal as it can occur fairly often. A three-bar confirmation in the
price action or in the MACD histogram can provide a confirmation signal.

In the chart examples that follow, you’ll see two red and blue lines at the bottom, representing
the two moving average time periods (fast and slow). The histogram in the middle has a line
running through the center, which creates a trigger or signal line.

First, we see a daily chart of the U.S. Dollar Index futures. In the lower part of the screen, there
is a moving average crossover of the 12-day and 26-day moving averages, represented by the tan
circle. We see the shift in price reflected in the corresponding tan circle in the candlestick chart
above. There is another crossover as the trend shifts to the positive side in the next set of light
blue circles.

Chart 1, Moving Average Crossover

2. Centerline Crossover. This occurs when the MACD moves past the zero line and moves into
the opposite territory. It can be combined with other types of indicators to confirm the signal.
Traders will often also monitor the slope of the histogram or the two indicator lines to reveal
increasing strength or weakness of the market momentum.

In Chart 2, we see the centerline crossover. The bars are steadily and slowly increasing, which
shows more buying coming in, and increased positive momentum. A bit of a bullish pennant
formation is seen in the price chart.

The purple bars (histograms) move below the zero line and then above as price rises (tan circles).
We then see a negative crossover. As the length of the histogram increases, the slope increases
and we see that in bearish price action (indicated by the light blue circles).
Chart 2, Center Line Crossover

3. Positive/Negative Divergence. This occurs when the strength or weakness of the MACD
differs from the relative price action of the market. It is the least common of all the MACD
signals, but is often the most reliable of the MACD signals, indicating a major trend shift.

On Chart 3, we see a high occur, and then a lower high on the MACD histogram, indicating
weakening or exhausting buying pressure. Afterward, we see a drop in price reinforced by the
drop in the MACD and MACD histogram. The market’s bottom should be indicated by a drop in
momentum.

Chart 3, Positive/Negative Divergence


4. Multiple Indicator Signal. If you have one indicator producing a signal, you might want to
reinforce it. As the MACD crossover goes from bearish to bullish in Chart 4, it is reinforced later
by a centerline crossover. We thus have two signals combining to reinforce the trade. We see an
increasing histogram, indicating increasing bullish momentum entering into the market, and
price action confirms the bullish shift. Within the light blue ellipses, we see multiple indicators.
The MACD crossover gives indications of a possible shift, and the centerline crossover indicates
increasing momentum.

Chart 4, Multiple Indicator Signal

This is just a brief introduction to MACD, and I encourage you to do further research and to
contact me with questions on how you might apply these techniques to your market analysis. I
find the MACD to be useful for all markets to determine momentum and trend shifts.

Dennis G. Cajigas is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted
division. He can be reached at (866) 631-6216 or by email at [email protected].

Kristina Landgraf is editor of Lind eWire. She can be reached at [email protected].

Futures trading involves substantial risk of loss and is not suitable for all investors.

Past performance is not necessarily indicative of future trading results. Trading advice is based
on information taken from trade and statistical services and other sources which Lind-Waldock
believes are reliable. We do not guarantee that such information is accurate or complete and it
should not be relied upon as such. Trading advice reflects our good faith judgment at a specific
time and is subject to change without notice. There is no guarantee that the advice we give will
result in profitable trades. All trading decisions will be made by the account holder.

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