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MOVING Average Convergence/Divergence
The MACD is a trend-following momentum indicator that shows the relationship between two exponential moving averages (EMAs) of an asset’s price. MACD falls into the lagging indicator category because the indicator tracks past pricing data. This makes MACD less useful for ranging assets (that are not trending) or those that are trading with unpredictable price action. However, the indicator can demonstrate whether the bullish or bearish movement in the price is strengthening or weakening and thereby help chartists to spot entry and exit points for trades.
The MACD indicator consists of three components:
- The MACD line
- The Signal line
- Histogram
There are numerous methods of interpreting the MACD indicator, but the most common methods to are divergences, crossovers, and rapid rises/falls.
MACD Divergences
A divergence occurs when MACD forms highs or lows that exceed the corresponding highs and lows on the asset’s price. A Bullish divergence occurs when the MACD forms two rising lows that correspond with two falling lows on the asset’s price, suggesting that the buying pressure is stronger despite the fall in price. Bullish divergences tend to lead to price reversals, possibly signaling a change in the trend to the upside.
A bearish divergence on the other hand, occurs when the MACD forms two falling highs that align with two rising highs on the asset’s price. This suggests that despite price growth, buying pressure is not as strong as it was. Bearish divergences during long-term bullish trends can indicate weakness in the trend.
MACD rapid rises/falls
When the underlying short-term moving average pulls away from the long-term moving average, a MACD rapid rises or falls occur signaling that an asset is in an overbought or oversold condition and will soon return to normal levels. But, because the MACD is a lagging indicator, traders typically compare this analysis with additional technical indicators like the Relative Strength Index (RSI) for the verification of the overbought or oversold conditions.
MACD crossovers
When MACD falls below the signal line, it is a bearish signal indicating that it may be time to sell. Conversely, when MACD rises above the signal line, the indicator gives a bullish signal, suggesting that the price of the asset is likely to experience upward momentum.
Crossovers are more reliable when they align with the prevailing trend. If MACD crosses above its signal line after a brief downside correction within a longer-term uptrend, it qualifies as a bullish confirmation and the likely continuation of the uptrend. Consequently, if MACD crosses below its signal line following a brief move higher within a longer-term downtrend, traders would consider that a bearish confirmation.
