MACD, which stands for Moving Average Convergence /
Divergence, is a technical analysis indicator created by
Gerald Appel in the 1960s. It shows the difference between a
fast and slow exponential moving average (EMA) of closing
prices. During the 1980's MACD proved to be a valuable tool
for any trader.
With the emergence of computerized analysis, it has become
highly unreliable in the modern era, and standard MACD based
trade execution now produces a greater distribution of losing
trades. Some additions have been made to MACD over the years
but even with the addition of the MACD histogram, it remains a
lagging indicator. It has often been criticized for failing to
respond in mild/volatile market conditions.
Since the crash of the market in 2000, most strategies no
longer recommend using MACD as the primary method of analysis,
but instead believe it should be used as a monitoring tool
only. It is prone to whipsaw, and if a trader is not careful
it is possible that they might suffer substantial loss,
especially if they are on margin or trading options. The
standard periods recommended back in the 1960's by Gerald
Appel are 12 and 26 days.
MACD is a trend following indicator, and is designed to
identify trend changes. It's generally not recommended for use
in ranging market conditions. Three types of trading signals
are generated,
- MACD line crossing the signal line.
- MACD line crossing zero
- Divergence between price and MACD levels
The signal line crossing is the usual trading rule. This is to
buy when the MACD crosses up through the signal line, or sell
when it crosses down through the signal line. These crossings
may occur too frequently, and other tests may have to be
applied.
The histogram shows when a crossing occurs. When the MACD line
crosses through zero on the histogram it is said that the MACD
line has crossed the signal line. The histogram can also help
visualizing when the two lines are coming together. Both may
still be rising, but coming together, so a falling histogram
suggests a crossover may be approaching.
A crossing of the MACD line up through zero is interpreted as
bullish, or down through zero as bearish. These crossings are
of course simply the original EMA(12) line crossing up or down
through the slower EMA(26) line.
Positive divergence between MACD and price arises when price
makes a new selloff low, but the MACD doesn't make a new low
(i.e. it remains above where it fell to on that previous price
low). This is interpreted as bullish, suggesting the downtrend
may be nearly over. Negative divergence is the same thing when
rising (i.e. price makes a new rally high, but MACD doesn't
rise as high as before), this is interpreted as bearish.
Divergence may be similarly interpreted on the price versus
the histogram, where the new price levels are not confirmed by
new histogram levels. Longer and sharper divergences (distinct
peaks or troughs) are regarded as more significant than small
shallow patterns in this case.
It is recommended to look at a MACD on a weekly scale before
looking at a daily scale to avoid making short term trades
against the direction of the intermediate trend.
Sometimes it is prudent to apply a price filter to the Bullish
Moving Average Crossover to ensure that it will hold. An
example of a price filter would be to buy if MACD breaks above
the 9-day EMA and remains above for three days. The buy signal
would then commence at the end of the third day. |
