Using the MACD Indicator

Invest Like A Pro! > Indicators > Using the MACD Indicator

MACD stands for moving average convergence divergence.  This indicator has been one of the most popular indicators for the past few decades.  MACD is a momentum indicator and can be useful for determining the strength of a given trend, overbought and oversold conditions as well as imminent reversal areas.  In basic terms, MACD plots the difference between two moving average lines.  The creator of the indicator, Gerald Appel, used exponential moving averages in his calculation.  The popular EMA lines used are 12 (fast) and 26 (slow) and the difference between these lines is displayed as the actual MACD line.  In addition, this indicator employs a Signal line, which is a moving average of the MACD line, in this case a 9 EMA.

I have always used the original MACD settings in my work with clients over the past 30 years.  MACD was the first indicator I used when I started in technical analysis and has continued to play a role in my interpretations of the trend and its strength.  An important factor is that since MACD is based on MA lines, it is calculated using the closing price of a stock.  The high and low range for each bar is completely ignored.  This fact will become more significant when I explain the use of the ADX indicator in the future articles.

If you browse through the example charts in my book, you will notice MACD is in the lower scale on every one of the charts.  There are specific signals and characteristics I look for when using this indicator in conjunction with the 18 MA and 40 MA lines.  I am sure you are wondering how a 12/26 EMA indicator would work with 18/40 SMA lines.  Keep in mind, the idea is to use the methods independently and then look for common ground.  I purposely started with articles related to the price action and trend.  The reason, as I stated earlier, is that you must become proficient at reading price patterns, trends and structure without the use of indicators before moving on.  It is critical that you develop the skill of seeing the trend and change of trend, preferably with only price bars on the chart.  Then, it becomes useful to use indicators to improve and enhance what you are already seeing with the price action.  To repeat, start with price bars, then add MA lines, followed by using the MACD or ADX or both. 

There are specific patterns that develop with MACD that I am going to cover with numerous examples.  The four most prominent signals for my work are zero line reversals, pinch plays, momentum divergence and reverse divergence.

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