Moving Average Convergence/Divergence is the next trend-following
dynamic indicator. It indicates the correlation between two price
moving averages.
The Moving Average Convergence/Divergence Technical Indicator is the
difference between a 26-period and 12-period
Exponential Moving Average (EMA).
In order to clearly show buy/sell opportunities, a so-called
signal line (9-period indicators` moving average) is plotted on the MACD chart.
The MACD proves most effective in wide-swinging trading markets.
There are three popular ways to use the Moving Average Convergence/Divergence: crossovers,
overbought/oversold conditions, and divergences.
Crossovers
The basic MACD trading rule is to sell when the MACD falls below
its signal line. Similarly, a buy signal occurs when the
Moving Average Convergence/Divergence
rises above its signal line. It is also popular to buy/sell when
the MACD goes above/below zero.
Overbought/oversold conditions
The MACD is also useful as an overbought/oversold indicator.
When the shorter moving average pulls away dramatically from
the longer moving average (i.e., the MACD rises),
it is likely that the security price is overextending and
will soon return to more realistic levels.
Divergence
An indication that an end to the current trend may be near occurs
when the MACD diverges from the security. A bullish divergence occurs
when the Moving Average Convergence/Divergence indicator is making new highs while prices fail to reach new highs.
A bearish divergence occurs when the MACD is making new lows while prices
fail to reach new lows. Both of these divergences are most significant
when they occur at relatively overbought/oversold levels.
Calculation
The MACD is calculated by subtracting the value of a 26-period exponential moving
average from a 12-period exponential moving average. A 9-period dotted simple
moving average of the MACD (the signal line) is then plotted on top of the MACD.
MACD = EMA(CLOSE, 12)-EMA(CLOSE, 26)
SIGNAL = SMA(MACD, 9)
Where:
EMA — the Exponential Moving Average;
SMA — the Simple Moving Average;
SIGNAL — the signal line of the indicator.