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The MACD Indicator - Understanding Its Concept And Benefits

December 30, 2013

Look at any charting program, and you will find many indicators and oscillators to help you with your technical analysis of the chart. One which is particularly liked by many traders, perhaps because it seems to provide more information than a regular indicator, is the Moving Average Convergence/Divergence (MACD) indicator.

Moving averages can be used to signal trading opportunities, and one of the ways they are used is by making a trigger of the crossover of two moving averages of different periods. The MacDee, as it is known, starts by calculating the difference between a fast exponential moving average and a slow exponential moving average, usually the EMA (12) and the EMA (26). The difference is plotted to make the MACD line.

However, the inventor of the MacDee, Gerald Appel, went a step further and generated an exponential moving average of the MACD value, usually taken as the EMA (9). This is called a signal line, and it acts on the moving average to provide a smoothing function to the value. Here is a chart showing the MacDee: 

This is a chart of Apple share values, and it illustrates the various MACD movements. The indicator is shown below the chart, with the darker line being the MACD line and the lighter line the signal line. The vertical bars provide a graphical indication of the difference between the two lines, therefore where the bars cross zero, it signifies that the two lines are crossing.

There are three distinct ways that the MacDee indicator is used. First, looking at the MacDee line crossing the signal line, if the MacDee is rising above the signal the Bulls are in control, and if the MacDee drops below the signal line the market is looking to drop lower. Look for instance at July and October where the line crossed above, and the market rallied.

Secondly, you can look for the MacDee crossing the zero level. If it rises above, then this indicates a bullish market. This chart is generally bullish, and you can see that the MACD is for the most part above the middle zero level. The line only goes below zero twice in the above chart, and each time there is a fall in price. Some analysts advise using this indication in conjunction with the lines crossing, as mentioned above, requiring both as confirmation to indicate the direction of the market.

Lastly, you can also look for divergence between MACD line and the market price. As with several other indicators, if the indicator and the price line diverge then it indicates that something is wrong, and you need to look for a change in trend. In the chart above you can see that the MACD peaks around 19th August, as does the price. The next price peak, which is almost up to the same level, is accompanied by a weak and much lower MACD line peak, which spells trouble, and sure enough the price quickly dropped.

The MACD is an indicator which is repays experimenting, as there are many different ways in which you can use it to enhance your trading.

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