MACD - Technical Analysis Indicator

The speaker provides a definition for the MACD, or moving average convergence divergence indicator.  He mentions that the most popular setttings for this indicator are the (12, 26, 9) settings.  MACD is the difference between the value of the 12 day and 26 day exponential moving averages.  The 9 day exponential moving average is then superimposed as the "signal line". 

MACD is a momentum oscillator which fluctuates above and below the 0 line and provides a live example to illustrate the calculation of this indicator.  Typically, with centering oscillators, a move above 0 is bullish while a move below is bearish. 

He mentions a simple strategy for trading the MACD crossovers and illustrates how it can call decent moves in the market.  He also covers the significance of divergences between the MACD and price movement in the chart and how one can use that divergence to spot a good buy or sell signal. 

Transcript of MACD - Technical Analysis Indicator

MACD Introduction

MACD is one of the most popular technical analysis tools out there. I see it everyday on people's charts. Here it is plotted along the bottom of this price graph. You know a lot of people use it but not everybody knows how to use it most effectively. Let’s begin by understanding what MACD is made up of.

Components of MACD

First of all of course MACD is short for moving average convergence divergence. The most common formula that is by default is used almost all charting packages is the 12, 26, 9 formula. The way it works is the MACD line is made up of the difference between the value of the 12 day and the 26 day exponential moving averages. Then a nine-day exponential moving average of the MACD is superimposed over the MACD as the signal line. MACD is what’s known as a centered oscillator. In other words, the MACD fluctuates above and below a centering line typically known as the 0 line. These types of oscillators are good for identifying strength or weakness or direction of momentum behind a securities move. As we talked about the formula, here are two exponential moving averages, the 12 and the 26 plotted right on a price chart. The faster moving average is the blue line, the 12 and the slower ema is the red line, the 26. You see the 12 is at 40 approximately and the 26 is at 38, so the difference between the two, the 40 minus the 38 gives us the MACD line. Here the MACD is plotted down below the black line that I'm pointing out is the MACD line you see it is at 2, that’s the 40 minus the 38, so it’s a positive two.

Interpreting the MACD

The MACD will fluctuate below and above the zero line typically with centering oscillators. When the oscillator is above the zero line we are in a bullish mode and when the oscillator is below the zero line we are in a bearish mode. This other line drawn here is the nine exponential moving average, the nine period EMA of the MACD of this black line itself. You know the moving averages in and of themselves are known to be lagging indicators and this chart represents that pretty well as you can see this move down turn right about here and it wasn't until about 5..6..7 days later the moving averages actual signaled the change. A real lag there and these are exponential moving averages they are actually faster than regular simple moving average. Simple moving averages would be slower yet again here is the change in direction and then the crossover in the moving averages didn't happen until you know a week and a half later. One last time, the change in direction happens way down here and about 6…7 days later the change in the crossover in the moving averages. Now, MACD on the other hand is much faster and much more responsive to the change. So, as you can see the change over the crossover MACD the crossing signal line happens here at the blue line and the red line shows how much more later it was that the actual moving average cross. Here again the MACD crossovers and here is the actual moving average crossover and again finally the MACD crossing over and it wasn't until much later that that moving average actually crossover. Now remember how MACD is created. The MACD is the difference between the 12 day and 26 day, so if MACD crosses above the zero line this indicates that the 12 day has crossed above the 26th day and so as you see the MACD crossing the zero line here is really representative of where the true moving averages are doing their crossover. As MACD is rising this is telling us that the gap between the 12 day and 26 day is widening, therefore indicating that bullish momentum is increasing. As MACD crosses down below the zero line we know that the 12 day has crossed down below the 26th day and as it continues in its downward path we can understand and assume that the distance between the two moving averages is widening therefore bearish sentiment is increasing. The momentum is strengthening in the downward trend as long as that MACD line is in descent. I would like to point out that the histogram represents the difference between MACD and its 9 day EMA. If you notice that as the histogram gets larger, this is representing how wide the distances between the MACD and the 9 day EMA. The histogram is positive when the MACD is above its nine day EMA. So in this case this here is where the MACD crossed over and it’s above the nine day. The histogram goes positive at that point and the histogram goes negative when the MACD is below the 9-day EMA.

MACD Divergence

Now another powerful tool in the MACD is the creation of divergences let me point some out. Here in March and April on this chart you can see price was increasing by this resistance line drawn above the price. But, MACD as you can see was falling. The peaks in the MACD were getting lower. This was kind of a heads up that there was a change imminent. Here is another divergence where price is creating lower lows shown by this descending support line but the MACD was having higher lows so again here is a heads up that a divergence between MACD and action and price. MACD telling us and warning us that there was a momentum of this down move was weakening and therefore a change was imminent. One more time, another example of a divergence lower lows and price higher lows in MACD and then immediately followed by a MACD crossover and a change in direction. It's important to notice as well that MACD was making higher lows but moving averages were making lower lows in this case. Here the moving averages were making lower lows but the MACD was making higher lows.