MACD Indicator – In Search of Divergence
The MACD indicator is a short abbreviation for moving average convergence divergence. It is a widely used indicator based on a calculation of exponential moving averages and a “signal” line. It is plotted in a separate window underneath the trading chart and can often come with a histogram showing the movement shaded in ranges.
The common calculation for an MACD indicator is to subtract the 26 period EMA from the 12 period and them plot a 9 period “signal” EMA over the end result. Check out this page a stockcharts.com for full mathematical equation.
When the 9 period EMA crosses the other EMA it is seen as a buy or sell indication. The accuracy of this however depends on how far to an extreme the MACD is within the indicator window. Often signal crosses near the zero line (horizontal line in center of window) can be small moves in price when it is consolidating. Also even at extremes the crosses can often just be short term retraces in the trend.
In short, it is a lagging indicator that has it’s flaws but can be useful in long time frames to determine the trend of a price.
Strategy and Ideas..
Rather than look for the EMAs to cross many traders looks for the EMAs to cross the zero line. This can show you a change in direction of price trend and is used by many as a momentum indicator. Also a divergence between price and the MACD can signal a direction change. For instance say a price makes a new high in a trend, but the MACD indicator makes a lower high in the window below. This is known as divergence, and often signals the start of a move in the opposite direction. As MACD is a lagging indicator, any strategy based around it should be back tested fully first.