Moving Average Convergence/Divergence (MACD)

Moving Average Convergence/Divergence is the next trend following dynamic indicator. It indicates the correlation between two price Exponential Moving Averages (EMA): fast EMA and slow EMA. In order to clearly show buy/sell opportunities, a Simple Moving Average (SMA) called signal line is plotted on the MACD chart.

Calculation

The MACD is calculate by subtracting the value of the faster EMA from the slower EMA. A dotted SMA (n periods) of the MACD is then plotted on top of the MACD.

MACD = EMA (faster) - EMA (slower)

Signal = SMA (MACD,n)

The MACD proves most effective in wide-swinging trading markets. There are three popular ways to use the MACD: crossovers, overbought/oversold conditions, and divergences.

Crossovers

The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy signal occurs when the MACD rises above its signal line. It is also popular to buy/sell when the MACD goes above/below zero.

Overbought/oversold conditions.

The MACD is also useful as an overbought/oversold indicator. When the faster EMA pulls away dramatically from the slower EMA, it is likely that the price is over-extending and will soon return to more realistic levels.

Divergence

An indication that an end to the current trend may be near occurs when the MACD diverges from the price. A bullish divergence occurs when the MACD is making a new high while price fail to reach a new high. A bearish divergence occurs when the MACD is making a new low while the price fail to reach a new low. Both of these divergences are most significant when the occur at relatively overbought/oversold levels.