Moving average convergence divergence (MACD) was devised by trader Gerald Appel. It is a technical trading tool that demonstrates the association between two moving averages of prices for assets, such as commodity futures or stocks. The MACD is often referred to as a trend following indicator. It is primarily used by traders to detect changes in the most recent trend. This technical trading tool is usually not used by traders in markets that are fixed in a trading range.
The MACD is computed by subtracting a 26-day exponential moving average or EMA from a 12-day exponential moving average. A more accurate interpretation of moving average convergence divergence is that the two lines represent a moving average that is the difference between both moving averages. A signal line is plotted on top of the MACD. It is used as a means of determining when to buy or sell an asset. The standard signal line is calculated as a nine-day exponential moving average. It is also called the trigger line.
There are basically three techniques that are used to evaluate and interpret moving average convergence-divergence. They are: crossovers, divergence, and zero line crossover. Crossovers can be bullish or bearish. When the MACD drops below the signal line, this bearish signal is an indication that it may be time to sell the asset. On the other hand, a MACD that rises above the signal line is bullish and an indication that prices may be going up. It is a signal to buy.
Divergence occurs when the price of the asset moves opposite the moving average convergence divergence, which is a signal that the present trend has ended. The zero line crossover takes place when the MACD line rises through the center line, which is zero. This is a bullish signal and may be a buy signal for traders. MACD lines that drop down through the zero line are bearish and therefore, a sell signal for many traders. Most technical traders utilize moving average convergence divergence one of many tools in their trading arsenal.
Typically, traders will examine the weekly MACD scale in order to get an intermediate perspective on the market before looking at the daily scale. This ensures that the trader does not execute short-term trades that go against the prevailing intermediate trend. Many traders take extra precaution by implementing a price filter before executing bullish trades on the moving average crossover. For example, they may require the moving average convergence divergence to rise above the nine-day EMA. It must remain there for a minimum of three days; at the close of the third day, the buy signal is issued.