MACD Simple Explanation and Strategy

What is MACD?

The Moving Average Convergence Divergence (MACD) indicator is a technical tool that helps traders identify trends and gauge their strength or momentum. It consists of the following elements:

  • The Exponential Moving Average (EMA), which is a type of moving average that gives more weight to recent price changes and reacts quicker to price action than a Simple Moving Average.
  • The MACD line, which is calculated as the difference between a 12-period EMA and a 26-period EMA.
  • The signal line, which is a 9-period EMA of the MACD line.
  • The baseline, which represents the point at which the 12-period EMA and 26-period EMA intersect and their difference is zero.
  • The histogram, which shows the difference between the MACD line and the signal line.

There are several ways to interpret MACD signals, with the most common being crossovers and divergences.

The story of MACD: Two people – one indicator

Gerald Appel developed the widely-used MACD indicator in the late 1970s. He had been a fund manager for 35 years before retiring in 2012 and used a quantitative, systematic approach based on long-term price studies in his trading. In 1986, technical analyst Thomas Aspray discovered that MACD signals were often generated late, especially on weekly charts, and attempted to address this issue by changing the periods of the moving averages used in the indicator. This change helped to produce signals earlier and Aspray added the histogram to the MACD to better represent the momentum in price movement. MACD crossovers are considered significant indicators of turning points in asset prices. Today, there are various variations of the MACD, such as the "Zero lag MACD," which interprets two moving averages.

MACD – how do you want it to be?

The Moving Average Convergence Divergence (MACD) indicator is most effective on higher timeframes, such as 4-hour, daily, and weekly charts. While there are fewer signals on these timeframes, traders can use different timeframes to filter out low-quality signals. For example, if the MACD is bullish on a daily chart, a trader may only consider buy signals on a 4-hour chart. The MACD can be adjusted to be more or less sensitive to price action, with the most common settings being 12, 26, and 9. The MACD can generate several types of signals, such as baseline crossovers, signal line crossovers, and divergences. As the MACD is a lagging indicator, it is best used in conjunction with other tools of analysis to determine the best entry and exit points for trades. The MACD is a versatile indicator that can identify trend changes, momentum, and divergences, but it is less reliable when price action becomes erratic.