This is a deep dive into the moving-average-convergence-divergence (MACD) indicator. Learn how it works, MACD strategies, its pitfalls, settings, when it is useful, and when it gives false signals. Understand the MACD on a deep level.

Here are a few key things to understand about the MACD indicator.

• If you plot a 12 and 26-period moving average on the chart, the MACD value is the distance between these moving averages. The MACD uses exponential moving averages (EMAs) so if you want to see how movement in the MACD corresponds to the moving average movement, use EMAs, with no smoothing, on your chart.
  
  
• When 12 crosses above the 26-period moving average, that is when the MACD moves above the zero line.
  
  
• When the 12 crosses below the 26, that is when the MACD crosses below the zero line.
  
  
• The signal line, which is the slower-moving line on the MACD indicator, has nothing to do with the price. It is simply a moving average of the MACD line. In other words, it is a slower-moving MACD.
  
  
• The histogram, if present, shows the distance between the MACD and the signal line. It is not derived from price movement directly. The MACD value is the price difference between the 12 and 26- period MAs, and the signal line is a moving average of the MACD.
  
  For example, if the 26 period is at $25 on the chart and the 12-period is at $26, then the MACD value is 1.0 (26-25). If the signal line is at 0.9, then the histogram will say 0.1 (1.0-0.90)
  
  
• There is a lot to talk about divergence with the MACD.
  
  Bearish divergence occurs when price makes a new high above a prior price high point, but the MACD doesn’t.
  
  Bullish divergence is when price makes a new low below a prior swing low, but the MACD doesn’t.
  
  These divergences can sometimes signal that the existing price trend is running out of steam and could reverse. But before jumping on such trades, understand that divergence will always occur in certain situations, and it doesn’t necessarily mean the price trend will end.
  
  
  • After a strong and fast price move, the moving averages that the MACD is measuring will spread out. This can create a big move in the MACD (which measures the distance between the two MAs). Big MACD moves often occur near the beginning or middle of the trends as more people get involved. The price moves that follow within the trend may not be as big or as fast. Thus the MACD may not move as much because the moving averages stay closer together. This does not mean the trend is over. It just means the moves are smaller or not as fast as the big price move that occurred earlier.
    
    
  • For example, if there is a very fast price up-move in a stock, possibly related to earnings, the MACD will spike higher as the moving averages separate/spread out (the 26 period reacts slower than the 12). The price then pulls back and starts moving up again. The price could rise slowly for months, but the MACD won’t spike because the slow rise in price means the moving averages stay pretty close to each other. The MACD may never reach its prior peak (that occurred right after the sharp upward price move), yet the price is still trending higher.
    
    
  • Because of this, if you opt to use the MACD, I recommend also using price action analysis to help determine the health of the trend. You may find that if your price action skills improve, you don’t need the MACD at all.
    
    Below is an example of a false bullish signal in a declining stock. Just because MACD wasn’t reaching new lows (it was making higher lows) doesn’t mean the price downtrend is over.

• Common settings for the MACD are 12 and 26, with the signal line set to a 9-period moving average of the MACD. You can play around with these and see if other settings work better for the market and time frame you are trading.
  
  
• MACD deals in dollar differences between moving averages. This can mean values become distorted over time. For example, if a stock rises over many years, the MACD values will get bigger over time because the dollar values are higher. PPO, the percentage price oscillator, uses percent movements instead of dollar movements and thus is better for comparing MACD levels over long periods of time. The chart below shows this difference over more than a decade in NVDA stock.
  

Cory Mitchell, CMT

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