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 he/she might suffer substantial loss, especially if he/she is on margin or trading options. The standard periods recommended back in the 1960's by Gerald Appel are 12 and 26 days:
MACD = EMA[12] of price- EMA[26] of price
A signal line (or trigger line) is then formed by smoothing this with a further EMA. The standard period for this is 9 days,
Signal = EMA[12] of MACD
histogram = MACD − signal
The example graph above right shows all three of these together. The upper graph is the prices. The lower graph has the MACD line in blue and the signal line in red. The solid white histogram style is the difference between them.
The set of periods for the averages, often written as say 12,26,9, can be varied. Appel and others have experimented with various combinations.
Interpretation
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