The moving average convergence divergence, or MACD, is one of many tools in the arsenal of a technical trader. Developed in 1979, it remains a popular, if often misunderstood indicator. There are several different elements to the MACD, which is one reason for confusion. The indicator charts the 12-day and 26-day exponential moving averages, and uses a histogram to reflect the difference between these two lines.
Watch for divergence. The most potent use for MACD is to spot divergences in price action. A divergence occurs when the trend in the MACD and actual price begin to move in opposite directions. For example, if a down-trending stock makes a new low in price, but while MACD does not reach new lows and actually moves upward, this is a positive divergence and suggests a buying opportunity. The opposite would be a negative divergence and suggests a chance to sell.
Spot centerline crossovers. The centerline, or zero-line, is the place where the difference between the fast and slow moving-average lines is nil. When the MACD lines move from negative to positive through the centerline, this is a bullish indication. A move from positive to negative suggests momentum has shifted and indicates continued weakness in price.
Confirm divergences with moving-average crossovers. A moving-average crossover is similar to a centerline crossover except that it occurs when the fast-moving line crosses over the slower-moving line. Because this can happen frequently, it is not considered a reliable indicator on its own. But, such crossovers are important in confirming positive and negative divergences. For example, a bullish moving average crossover occurring after MACD indicates a positive divergence is considered a reliable indication that a positive change in trend is about to occur.
The MACD can be useful in providing both entry and exit points, but should always be used in conjunction with price action and other technical indicators. When used correctly, it is an effective measure of trend and momentum.
One of the major drawbacks to the MACD is that it relies on moving average, which are lagging indicators by their nature. This means the MACD is less useful for day traders and those looking for very short-term trades. However, it can be quite useful for swing traders and those looking for major trend reversals and intermediate-term trades or investments.