MACD - Moving Average Convergence/Divergence
MACD, pronounced "Mac D", stands for Moving Average Convergence/Divergence and was invented by Gerald Appel. It is one of the simplest indicators, yet considered quite reliable. It is considered particularly effective in wide-swinging markets. The MACD indicator is referred to as an oscillator, because the MACD curve swings back and forth across zero. The oscillator does not have any upper or lower limits.
The MACD graph shows two curves. The first curve is the MACD itself, defined as:
MACD = EMAn1-EMAn2
where EMAn1 is the n1-period exponentially smoothed moving average of the currency price, and EMAn2 is the n2-period exponentially smoothed moving average of the currency price. Values for n1 and n2 are typically chosen as 12 and 26, respectively, or 10 and 20, when the markets are volatile. When the n1 period moving average is greater than the n2-period moving average, the MACD line is positive and negative otherwise. The MACD line is plotted as a blue line.
The second curve is an n-period exponential average of the MACD line, with n typically being 9 (or 5 when the markets are volatile). This second line is plotted as a white line. Because it is a moving average of the MACD line, it will be smoother and move more slowly.
The difference between the two lines is shown as a shaded curve.
The MACD has three parameters:
- n1: the number of periods used in the first exponentially smoothed moving average of the MACD formula.
- n2: the number of periods used in the second exponentially smoothed moving average of the MACD forumla.
- n: the number of periods used to smooth the MACD line when generating the second line.
The MACD is typically used to identify overbought and oversold situations, and for identifying trading signals.
The indicator is considered to identify an oversold situation when the MACD is falling and pulls away rapidly from its moving average. In that case, the exchange rate is expected to go up in the near future. Conversely, the indicator is considered to identify an overbought situations occur when the MACD is rising and pulls away rapidly from its moving average. In that case, the currency price is expected to go down in the near future.
Trading signals are identified with the MACD indicator in a number of ways:
- Trigger line signal: Some argue that a buy signal is generated when the MACD crosses and goes above zero, and that a sell signal is generated when the MACD crosses and goes below zero.
- Crossover signal: Others interpret a “crossover” as a signal: when the MACD crosses and falls below its moving average, a sell signal is generated, and when the MACD crosses and rises above its moving average, a buy signal is generated.
- Divergence signal: When the MACD does not follow the current trend and moves counter to the direction of the corresponding exchange rate, then this is interpreted as a warning that the currency's trend may change. Hence, when the MACD is moving down while the exchange rate is still rising, then this may be interpreted as a sell signal. A stronger sell signal occurs when the MACD is reaching new lows while the corresponding exchange rate is still moving up. Conversely, when the MACD is moving up while the exchange rate is still falling, then this may be interpreted as a buy signal. A stronger buy signal occurs when the MACD is reaching new highs while the corresponding exchange rate is still going down.