What Is MACD? - Moving Average Convergence/Divergence - Fidelity (2024)

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What Is MACD? - Moving Average Convergence/Divergence - Fidelity? ›

The Moving Average Convergence/Divergence (MACD) indicator shows the relationship between 2 moving averages of prices. MACD is derived by dividing one moving average by another. It is based on the point spread difference between 2 exponential moving averages of the closing price.

Description. The Moving Average Convergence/Divergence indicator is a momentum oscillator primarily used to trade trends. Although it is an oscillator, it is not typically used to identify over bought or oversold conditions. It appears on the chart as two lines which oscillate without boundaries.

MACD is a trend-following momentum indicator that shows the relationship between two moving averages of a security's price. Traders use the MACD to identify entry and exit points for trades. MACD is used by technical traders in stock, bond, commodities, and FX markets.

When MACD forms highs or lows that exceed the corresponding highs and lows on the price, it is called a divergence. A bullish divergence appears when MACD forms two rising lows that correspond with two falling lows on the price. This is a valid bullish signal when the long-term trend is still positive.

The standard setting for MACD is the difference between the 12- and 26-period EMAs. Chartists looking for more sensitivity may try a shorter short-term moving average and a longer long-term moving average. MACD(5,35,5) is more sensitive than MACD(12,26,9) and might be better suited for weekly charts.

The use of the values 12 and 26 in the MACD calculation is a historical choice that has become widely accepted in technical analysis. The number 12 represents the shorter-term exponential moving average (EMA), capturing shorter price trends, while 26 represents the longer-term EMA, capturing longer price trends.

The best way to trade moving average is to use the crossover strategy, where a shorter-period moving average crossing above a longer-period moving average generates a bullish signal, and vice versa for a bearish signal. This method helps indicate potential changes in the market trend.

The strongest divergences are Class A divergences; exhibiting less strength are Class B divergences, and the weakest divergences are Class C. The best trading opportunities are indicated by Class A divergences, while Class B and C divergences represent choppy market action and should generally be ignored.

But everything else being equal, an EMA will track price more closely than an SMA. Because of this, the EMA is typically considered more appropriate in short-term trading. The same characteristics that make the EMA better suited for short-term trading limit its effectiveness when it comes to the long term.

Increasing the number of periods for the signal line will reduce the number of crossover signals, helping avoid false signals. However, trade signals will occur later than they would with a shorter signal line EMA. The indicator can be applied to any timeframe, but it's preferable to choose those from H1 and bigger.

How to use MACD to buy and sell? ›

Short-term buy-and-sell signals are generated by the MACD line and the signal line. If the MACD line crosses above the signal line, this may be interpreted as a buy signal. Alternatively, if the MACD line crosses below the signal line, this may be interpreted as a sell signal.

While the MACD has many strengths and can help traders spot trend reversals, it is not infallible and struggles, particularly in sideways markets. Since the MACD is based on underlying price points, overbought and oversold signals are not as effective as a pure volume-based oscillator.

Drawbacks of MACD

Traders should be aware that the whipsaw effect can be severe in both trending and range-bound markets because relatively small movements can cause the indicator to change directions quickly. A large number of false signals can result in a trader taking many losses.

Strong trend: When the market is in a strong trend, the MACD may lag behind the price action and generate signals too late. Traders may want to use other indicators, such as the Relative Strength Index (RSI) or the Stochastic Oscillator, to complement the MACD in these situations.

MACD with PRC has a 90% success rate. A stock's moving averages should at least approach one another, if not cross, before you act on that stock. MACDs rely on three exponential moving averages instead of one or two. Look for patterns where the three moving averages come together closely.

Simple MACD strategy

With this strategy, the orders are opened as follows: If the MACD histogram crosses the moving average upwards, the buy order will be placed. If the MACD histogram crosses the moving average downwards, the sell order will be placed.

One of the main problems with divergence is that it often signals a (possible) reversal but no actual reversal occurs—a false positive. The other problem is that divergence doesn't forecast all reversals. In other words, it predicts too many reversals that don't occur and not enough real price reversals.

The best RSI signal occurs when both MACD lines are rising and in a buy mode, meaning that the main line is above the signal line and both lines are rising. A rising MACD means the overall direction is up. A rising RSI indicates that a new upward move is expected in the direction of the trend, defined by the MACD.

ROC is also commonly used as a divergence indicator that signals a possible upcoming trend change. Divergence occurs when the price of a stock or another asset moves in one direction while its ROC moves in the opposite direction.