What Is Moving Average

Convergence/Divergence (MACD)?

Moving average convergence/divergence (MACD, or MAC-D)

is a trend-following momentum indicator that shows the

relationship between two exponential moving averages

(EMAs) of a security’s price. The MACD line is calculated by

subtracting the 26-period EMA from the 12-period EMA.

The result of that calculation is the MACD line. A nine-day

EMA of the MACD line is called the signal line, which is then

plotted on top of the MACD line, which can function as a

trigger for buy or sell signals. Traders may buy the security

when the MACD line crosses above the signal line and sell—or

short—the security when the MACD line crosses below the

signal line. MACD indicators can be interpreted in several

ways, but the more common methods

are crossovers, divergences, and rapid rises/falls.

KEY TAKEAWAYS
The moving average convergence/divergence (MACD, or

MAC-D) line is calculated by subtracting the 26-period

exponential moving average (EMA) from the 12-period

EMA. The signal line is a nine-period EMA of the MACD

line.

MACD is best used with daily periods, where the traditional

settings of 26/12/9 days is the default.

MACD triggers technical signals when the MACD line

crosses above the signal line (to buy) or falls below it (to sell).

MACD can help gauge whether a security is overbought or

oversold, alerting traders to the strength of a directional

move, and warning of a potential price reversal.

MACD can also alert investors to bullish/bearish

divergences (e.g., when a new high in price is not confirmed

by a new high in MACD, and vice versa), suggesting a

potential failure and reversal.

After a signal line crossover, it is recommended to wait for

three or four days to confirm that it is not a false move.

MACD Formula

MACD=12-Period EMA − 26-Period EMAMACD=12-Period EMA − 26-Period

EMA

MACD is calculated by subtracting the long-term EMA (26

periods) from the short-term EMA (12 periods). An EMA is a

type of moving average (MA) that places a greater weight

and significance on the most recent data points.

The exponential moving average is also referred to as the

exponentially weighted moving average. An exponentially

weighted moving average reacts more significantly to

recent price changes than a simple moving average (SMA),

which applies an equal weight to all observations in the

period.

Learning from MACD

MACD has a positive value (shown as the blue line in the lower

chart) whenever the 12-period EMA (indicated by the red

line on the price chart) is above the 26-period EMA (the blue
line in the price chart) and a negative value when the

12-period EMA is below the 26-period EMA. The level of

distance that MACD is above or below its baseline indicates

that the distance between the two EMAs is growing.

In the following chart, you can see how the two EMAs applied

to the price chart correspond to the MACD (blue) crossing

above or below its baseline (red dashed) in the indicator below

the price chart.

MACD is often displayed with a histogram (see the chart

below) that graphs the distance between MACD and its

 signal line. If MACD is above the signal line, the histogram

will be above the MACD’s baseline, or zero line. If MACD is

below its signal line, the histogram will be below the

MACD’s baseline. Traders use the MACD’s histogram to

identify when bullish or bearish momentum is high—and

possibly for overbought/oversold signals.

MACD vs. Relative Strength

The relative strength index (RSI) aims to signal whether a

market is considered to be overbought or oversold in relation

to recent price levels. The RSI is an oscillator that calculates

average price gains and losses over a given period of time. The

default time period is 14 periods with values bounded from 0

to 100. A reading above 70 suggests an overbought condition,

while a reading below 30 is considered oversold, with both

potentially signaling a top is forming, or vice versa (a bottom

is forming).

The MACD lines, however, do not have concrete

overbought/oversold levels like the RSI and other oscillator

studies. Rather, they function on a relative basis. That’s to say

an investor or trader should focus on the level and direction

of the MACD/signal lines compared with preceding price

movements in the security at hand, as shown below.

MACD measures the relationship between two EMAs, while

the RSI measures price change in relation to recent price highs

and lows. These two indicators are often used together to

give analysts a more complete technical picture of a market.

These indicators both measure momentum in a market, but

because they measure different factors, they sometimes give

contrary indications. For example, the RSI may show a

reading above 70 (overbought) for a sustained period of time,

indicating a market is overextended to the buy side in

relation to recent prices, while the MACD indicates that the

market is still increasing in buying momentum. Either

indicator may signal an upcoming trend change by showing

divergence from price (price continues higher while the

indicator turns lower, or vice versa).

Limitations of MACD and Confirmation

One of the main problems with a moving average divergence

is that it can often signal a possible reversal, but then no

actual reversal happens—it produces a false positive. The

other problem is that divergence doesn’t forecast all reversals.

In other words, it predicts too many reversals that don’t

occur and not enough real price reversals.

This suggests confirmation should be sought by

trend-following indicators, such as the Directional Movement

Index (DMI) system and its key component, the Average

Directional Index (ADX). The ADX is designed to indicate

whether a trend is in place or not, with a reading above 25

indicating a trend is in place (in either direction) and a

reading below 20 suggesting no trend is in place.

Investors following MACD crossovers and divergences should

double-check with the ADX before making a trade on an

MACD signal. For example, while MACD may be showing a

bearish divergence, a check of the ADX may tell you that a

trend higher is in place—in which case you would avoid the

bearish MACD trade signal and wait to see how the market

develops over the next few days.

On the other hand, if MACD is showing a bearish crossover

and the ADX is in non-trending territory (<25) and has likely

shown a peak and reversal on its own, you could have good

cause to take the bearish trade.

Furthermore, false positive divergences often occur when the

price of an asset moves sideways in a consolidation, such as in

a range or triangle pattern following a trend. A slowdown in

the momentum—sideways movement or slow trending

movement—of the price will cause MACD to pull away from

its prior extremes and gravitate toward the zero lines even in

the absence of a true reversal. Again, double-check the ADX

to determine whether a trend is in place and also look at what

price is doing before acting.

Example of MACD Crossovers

As shown on the following chart, when MACD falls below the

signal line, it is a bearish signal indicating that it may be time

to sell. Conversely, when MACD rises above the signal line, the

signal is bullish, suggesting that the price of the asset might

experience upward momentum. Some traders wait for a

confirmed cross above the signal line before entering a

position to reduce the chances of being faked out and entering

a position too early.

Crossovers are more reliable when they conform to the

prevailing trend. If MACD crosses above its signal line after a

brief downside correction within a longer-term uptrend, it

qualifies as a bullish confirmation and the likely continuation

of the uptrend.

If MACD crosses below its signal line following a brief move

higher within a longer-term downtrend, traders would

consider that a bearish confirmation.

Example of Divergence

When MACD forms highs or lows that that exceed the

corresponding highs and lows on the price, it is called a

divergence. A bullish divergence appears when MACD forms

two rising lows that correspond with two falling lows on the

price. This is a valid bullish signal when the long-term trend

is still positive.

Some traders will look for bullish divergences even when the

long-term trend is negative because they can signal a change

in the trend, although this technique is less reliable.

When MACD forms a series of two falling highs that

correspond with two rising highs on the price, a bearish

divergence has been formed. A bearish divergence that

appears during a long-term bearish trend is considered

confirmation that the trend is likely to continue.

Some traders will watch for bearish divergences during

long-term bullish trends because they can signal weakness in

the trend. However, it is not as reliable as a bearish divergence

during a bearish trend.

Example of Rapid Rises or Falls

When MACD rises or falls rapidly (the shorter-term moving

average pulls away from the longer-term moving average), it

is a signal that the security is overbought or oversold and will

soon return to normal levels. Traders will often combine this

analysis with the RSI or other technical indicators to verify

overbought or oversold conditions.

It is not uncommon for investors to use the MACD’s histogram

the same way that they may use the MACD itself. Positive or

negative crossovers, divergences, and rapid rises or falls can be

identified on the histogram as well. Some experience is needed

before deciding which is best in any given situation, because

there are timing differences between signals on the MACD and

its histogram.