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MACD was developed by Gerald Appel as a way to keep track of a moving average crossover system.
MACD, short for Moving Average Convergence/Divergence, is a trading indicator used in technical analysis of forex currencies or stock prices, created by Gerald Appel in the late 1970s. It was created as a way of keeping track of the moving average crossover system.
Basically, it is a trend-following momentum indicator that indicates the relationship between two moving averages of the price of a security. It has the feature of both momentum and moving average analysis to measure momentum in price movement.
It’s made up of three components
- MACD line
- The centerline
- The signal line
The MACD gives the difference between two exponential moving averages plotted around a centerline. The Centerline gives the area at which the two moving averages are equal. The signal line keeps track of the exponential moving average of the MACD.
Mathematically, MACD is the difference between two exponentially smoothed moving averages of closing prices and is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.
The result of that calculation is the MACD line. A nine-day EMA of the MACD called the “signal line,” is then plotted on top of the MACD line, which can function as a trigger for buy and sell signals.
MACD itself is displayed in a separate window under the chart. It looks like a histogram with an auxiliary line. The histogram shows the divergence of the two exponential moving averages.
If one of them moves away from the other, the histogram bars become longer. If the moving averages get closer, the bars become shorter. The auxiliary line is a 9 period exponentially smoothed average that has been calculated based on the MACD histogram.
Figure: MACD setup
- Default parameters of the indicator are Fast EMA 26, Slow EMA 12, MACD EMA 9
Figure 2: MACD set up steps
Figure 3: MACD setup parameters
this is a screenshot of the MACD indicator set up on the ACT brokers trading platform. You can see that the overbought region in the MACD indicator matches the peak in the price and the oversold region in the MACD matches the price lows. Therefore, the oversold region gives the buy entry point, while the overbought region gives the sell entry point.
Figure 4: MACD overbought and oversold region
MACD Histogram Crossover of the Zero Line
Histogram Crossover of the Zero Line: Buy/sell signals when the MACD goes above/below zero (known as a “centerline crossover”). Buy or sell trades when the price has momentum and the histogram is above or below the signal line.
Exit the trade if the momentum of the price decelerates.
Figure 5: MACD histogram crossover of the zero line
MACD Histogram Crossover of the Signal Line
- Buy if the Histogram of the MACD rises above its signal line in an uptrend and close if the Histogram falls below it.
- sell if the Histogram of the MACD falls below the signal line and closes if it rises above it.
Figure 6: MACD histogram crossover of the signal line