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The MACD indicator is one of the most popular technical analysis tools. There are three main components of the MACD shown in the picture below:
- MACD: The 12-period exponential moving average (EMA) minus the 26-period EMA.
- MACD Signal Line: A 9-period EMA of the MACD.
- MACD Histogram: The MACD minus the MACD Signal Line.
The MACD indicator is a versatile tool. There are three main ways to interpret the MACD technical analysis indicator, discussed on the following three sections:
- Moving Average Crossovers
- MACD Histogram
- MACD Divergences
MACD Moving Average Crossovers
The primary method of interpreting the MACD is with moving average crossovers.
When the shorter-term 12-period exponential moving average (EMA) crosses over the longer-term 26-period EMA a potential buy signal is generated; this is seen on the Nasdaq 100 exchange traded fund (QQQQ) chart below with the two purple lines.
Remember that the MACD line (the blue line) is created from the 12-period and 26-period EMA. Consequently:
- When the shorter-term 12-period EMA crosses above the longer-term 26-period EMA, the MACD line crosses above the Zero line.
- When the 12-period EMA crosses below the 26-period EMA, the MACD line crosses below the Zero line.
Moving Average Crossover Potential Buy Signal
A possible buy signal is generated when the MACD (blue line) crosses above the zero line.
Moving Average Crossover Potential Sell Signal
When the MACD crosses below the zero line, then a possible sell signal is generated.
The prior potential buy and sell signals might get a person into a trade later in the move of a stock or future. Another potential buy and sell signal is shown in the graph below of the Nasdaq 100 exchange traded fund QQQQ:
Most Common MACD Potential Buy and Sell Signals
MACD Potential Buy Signal
A potential buy signal is generated when the MACD (blue line) crosses above the MACD Signal Line (red line).
MACD Potential Sell Signal
Similarly, when the MACD crosses below the MACD Signal Line a possible sell signal is generated.
The MACD moving average crossover is one of many ways to interpret the MACD technical indicator. Using the MACD histogram and MACD divergence warnings are two other methods of using the MACD.
The MACD Histogram is simply the difference between the MACD line (blue line) and the MACD signal line (red line). The MACD histogram is illustrated in the chart below of the Nasdaq 100 QQQQ's:
Two important terms are derived from the MACD histogram and are illustrated above in the chart of the QQQQ's:
- Convergence: The MACD histogram is shrinking in height. This occurs because there is a change in direction or a slowdown in the stock, future, bond, or currency trend. When that occurs, the MACD line is getting closer to the MACD signal line.
- Divergence: The MACD histogram is increasing in height (either in the positive or negative direction). This occurs because the MACD is accelerating faster in the direction of the prevailing market trend.
When a stock, future, or currency pair is moving strongly in a direction, the MACD histogram will increase in height. When the MACD histogram does not increase in height or begins to shrink, the market is slowing down and might be warning of a possible reversal. The graph below of the E-mini Nasdaq 100 Index Future shows this phenomenon:
The letter “T” represents when the top or peak of the MACD histogram occurs. In contrast, the letter “B” shows when the bottom of the MACD histogram occurs. Notice in this example how closely the tops and bottoms of the MACD histogram are to the tops of the Nasdaq 100 e-mini future price action.
MACD Histogram Potential Buy Signal
When the MACD histogram is below the zero line and begins to converge towards the zero line.
MACD Histogram Potential Sell Signal
When the MACD histogram is above the zero line and begins to converge towards the zero line.
Note: In the example above, three consecutive days of shrinking MACD histogram from top or bottom served as possible buy or sell signals, these are shown with arrows.
This is an agressive example. A trader might wait until the MACD histogram went to zero, but that would be the same signal as the MACD moving average crossover.
In addition to signaling potential buy or sell signals, the MACD could be used for warnings of potential change in the direction of stocks, futures, and currency pairs.
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.
These divergences might signal a trader to get out of a long or short position before profits erode. The following chart of the E-mini S&P 500 Index Future shows some of these divergences:
High #1 to High #2
Looking at the E-mini S&P 500 future, from High #1 to High #2, the futures contract made higher highs, which is usually viewed as bullish. However, the MACD moving average failed to make a new high. This bearish divergence acted as an early warning sign of things to come with the E-mini S&P 500 futures contract.
Low #1 to Low#2
In yet another bearish sign for the E-mini S&P 500 futures contract, the future made higher lows from Low #1 to Low #2, which again is usually considered positive. Nevertheless, the MACD technical indicator made a clear lower low from Low #1 to Low #2. This bearish divergence warned of the impending downturn of the S&P 500 future and the market as a whole.
Low #2 to Low #3
In addition to bearish and bullish divergences, the MACD might confirm price movement as well. The E-mini S&P 500 futures contract made a substantial lower low which was confirmed by the MACD when it made a lower low as well.
As seen throughout the MACD sections, the MACD is a versatile tool giving a trader possible buy and sell entries and giving warnings of potential price changes.