Moving Average Convergence-

Divergence (MACD)
Introduction

Developed by Gerald Appel in the late seventies, Moving Average

Convergence-Divergence (MACD) is one of the simplest and most
effective momentum indicators available. MACD turns two trend-
following indicators, moving averages, into a momentum
oscillator by subtracting the longer moving average from the
shorter moving average. As a result, MACD offers the best of both
worlds: trend following and momentum. MACD fluctuates above
and below the zero line as the moving averages converge, cross
and diverge. Traders can look for signal line crossovers, centerline
crossovers and divergences to generate signals. Because MACD is
unbounded, it is not particularly useful for identifying overbought
and oversold levels.

Calculation

MACD: (12-day EMA - 26-day EMA)

Signal Line: 9-day EMA of MACD

MACD Histogram: MACD - Signal Line

Standard MACD is the 12-day Exponential Moving Average (EMA)

less the 26-day EMA. Closing prices are used for these moving
averages. A 9-day EMA of MACD is plotted with the indicator to
act as a signal line and identify turns. The MACD-Histogram
represents the difference between MACD and its 9-day EMA, the
signal line. The histogram is positive when MACD is above its 9-
day EMA and negative when MACD is below its 9-day EMA.

Interpretation

As its name implies, MACD is all about the convergence and divergence of the two moving averages.
Convergence occurs when the moving averages move towards each other. Divergence occurs when the
moving averages move away from each other. The shorter moving average (12-day) is faster and
responsible for most MACD movement. The longer moving average (26-day) is slower and less reactive
to price changes in the underlying security.

MACD oscillates above and below the zero line, which is also known as the centerline. These crossovers
signal that the 12-day EMA has crossed the 26-day EMA. The direction, of course, depends on direction
of the moving average cross. Positive MACD indicates that the 12-day EMA is above the 26-day EMA.
Positive values increase as the shorter EMA diverges further from the longer EMA. This means upside
momentum is increasing. Negative MACD indicates that the 12-day EMA is below the 26-day EMA.
Negative values increase as the shorter EMA diverges further below the longer EMA. This means
downside momentum is increasing.
In the example above, the yellow area shows MACD in negative territory as the 12-day EMA trades below
the 26-day EMA. The initial cross occurred at the end of September (black arrow) and MACD moved
further into negative territory as the 12-day EMA diverged further from the 26-day EMA. The orange area
highlights a period of positive MACD, which is when the 12-day EMA was above the 26-day EMA. Notice
that MACD remained below 1 during this period (red dotted line). This means the distance between the
12-day EMA and 26-day EMA was less than 1 point, which is not a big difference.

Signal Line Crossovers

Signal line crossovers are the most common MACD signals. The signal line is a 9-day EMA of MACD. As
a moving average of the indicator, it trails MACD and makes it easier to spot turns in MACD. A bullish
crossover occurs when MACD turns up and crosses above the signal line. A bearish crossover occurs
when MACD turns down and crosses below the signal line. Crossovers can last a few days or a few
weeks, it all depends on the strength of the move.

Due diligence is required before relying on these common signals. Signal line crossovers at positive or
negative extremes should be viewed with caution. Even though MACD does not have upper and lower
limits, chartists can estimate historical extremes with a simple visual assessment. It takes a strong move
in the underlying security to push momentum to an extreme. Even though the move may continue,
momentum is likely to slow and this will usually produce a signal line crossover at the extremities.
Volatility in the underlying security can also increase the number of crossovers.

Chart 2 shows IBM with its 12-day EMA (green), 26-day EMA (red) and MACD (12,26,9) in the indicator
window. There were eight signal line crossovers in six months: four up and four down. There were some
good signals and some bad signals. The yellow area highlights a period when MACD surged above 2 to
reach a positive extreme. There were two bearish signal line crossovers in April and May, but IBM
continued trending higher. Even though upward momentum slowed after the surge, upward momentum
was still stronger than downside momentum in April-May. The third bearish signal line crossover in May
resulted in a good signal.

Centerline Crossovers

Centerline crossovers are the next most common MACD signals. A bullish centerline crossover occurs
when MACD moves above the zero line to turn positive. This happens when the 12-day EMA of the
underlying security moves above the 26-day EMA. A bearish centerline crossover occurs when MACD
moves below the zero line to turn negative. This happens when the 12-day EMA moves below the 26-day
EMA.
Centerline crossovers can last a few days or a few months. It all depends on the strength of the trend.
MACD will remain positive as long as there is a sustained uptrend. MACD will remain negative when
there is a sustained downtrend. Chart 3 shows Pulte Homes (PHM) with at least four centerline crosses in
nine months. The resulting signals worked well because strong trends emerged with these centerline
crossovers.

Divergences

Divergences form when MACD diverges from the price action of the underlying security. A bullish
divergence forms when a security records a lower low and MACD forms a higher low. The lower low in
the security affirms the current downtrend, but the higher low in MACD shows less downside momentum.
Despite less downside momentum, downside momentum is still outpacing upside momentum as long as
MACD remains in negative territory. Slowing downside momentum can sometimes foreshadows a trend
reversal or a sizable rally.
A bearish divergence forms when a security records a higher high and MACD forms a lower high. The
higher high in the security is normal for an uptrend, but the lower high in MACD shows less upside
momentum. Even though upside momentum may be less, upside momentum is still outpacing downside
momentum as long as MACD is positive. Waning upward momentum can sometimes foreshadow a trend
reversal or sizable decline.
Divergences should be taken with caution. Bearish divergences are commonplace in a strong uptrend,
while bullish divergences occur often in a strong downtrend. Yes, you read right. Uptrends often start with
a strong advance that produces a surge in upside momentum (MACD). Even though the uptrend
continues, it continues at a slower pace that causes MACD to decline from its highs. Upside momentum
may not be as strong, but upside momentum is still outpacing downside momentum as long as MACD is
above the zero line. The opposite occurs at the beginning of a strong downtrend.

Conclusions

MACD is special because it brings together momentum and trend in one indicator. This unique blend of
trend and momentum can be applied to daily, weekly or monthly charts. The standard setting for MACD is
the difference between the 12 and 26-period EMAs. Chartists looking for more sensitivity may try a
shorter short-term moving average and a longer long-term moving average. MACD(5,35,5) is more
sensitive than MACD(12,26,9) and might be better suited for weekly charts. Chartists looking for less
sensitivity may consider lengthening the moving averages. A less sensitive MACD will still oscillate
above/below zero, but the centerline crossovers and signal line crossovers will be less frequent.

MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to
identify levels that are historically overbought or oversold, MACD does not have any upper or lower limits
to bind its movement. MACD can continue to overextend beyond historical extremes during sharp moves.
MACD calculates the absolute difference between two moving averages. This means MACD values are
dependent on the price of the underlying security. MACD for a $20 stocks may range from -1.5 to 1.5,
while MACD for a $100 may range from -10 to +10. It is not possible to compare MACD values for a
group of securities with varying prices. An alternative is to use the Percentage Price Oscillator (PPO),
which shows the percentage difference between two moving averages.