Moving Average Convergence Divergence is a technical analysis indicator which identifies the relationship between two moving averages of price, which reflects market trends. MACD was developed by Gerald Appel, the president of Signalert Corporation of Great Neck (New York), an investment advisory firm.

The reason why MACD indicator turned out to be so popular is because it allows you to recognize and follow strong trends in the market as well as recognizing trend reversals.

There are two different sets of moving averages that traders can use in order to calculate MACD’s. The first is a 12 day exponential moving average (EMA) together with a 26 day exponential moving average, and the second is a 19 day EMA together with a 39 day EMA.

Crossovers

When the MACD drops under the signal line (bearish signal), it indicates that it is better to consider selling. On the other hand, when the MACD rises over the signal line (bullish signal), it indicates that the price of the asset will probably experience an upward movement.

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Three common methods to use the MACD

Furthermore, when the MACD is higher than zero, the short-term moving average is higher than the long-term moving average and it indicates an upward movement and conversely when the MACD is lower than zero. The position zero in this case acts as an area of support and resistance for the indicator.

For example, the 12-26 day MACD, is calculated each day as follows:

12 day EMA – 26 day EMA

macd_divergence

What is Moving Average

Resources

Books

1. Steve Nison (2001), Japanese Candlestick Charting Techniques, Second Edition, Prentice Hall Pr.

2. G. L. Morris, R. Litchfield (2006), Candlestick Charting Explained: Timeless Techniques for Trading Stocks And Futures, McGraw-Hill Professional

Other sources

WORCESTER POLYTECHNIC INSTITUTE (2011), Automated Foreign Exchange Trading System, An Interactive Qualifying Project Report

TradeStation. (2002-2007). Getting Started With Forex Trading: A Forex Primer. Retrieved April 30, 2011, from TradeStation: https://www.tradestation.com/support/books/pdf/introduction_to_forex_trading.pdf

http://www.missingstep.com/blog/tag/dramatic-rise/

http://www.onlinetradingconcepts.com/TechnicalAnalysis/MACD4.html

A 9 day EMA of the MACD, is then drawn on top indicating buy and sell signals.

Divergence

When the price moves away from the MACD it indicates to traders that the current trend has come to an end.

Bearish divergence occurs when a technical analysis indicator is suggesting that a price should be going down but the price of the stock, future, or currency pair is continuing to maintain its current uptrend.

Bullish divergence occurs when the indicator is indicating that price should be bottoming and heading higher, yet the actual price action is continuing downward.

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Dramatic Rise

When the shorter moving average moves to distance from the longer-term moving average, it indicated that the security is overbought and shortly return to normal levels.