Moving Average Convergence/Divergence measures momentum of a particular stock based on the combination of multiple exponential moving averages. In other words, they give you a good idea of the the current trend of a stock is.
Before continuing this article, first makes sure you know what moving averages and moving average crossovers are.
The default formula for most MACD is the difference between a security’s 26-day and 12-day exponential moving averages (EMAs); however, just like with most other indicators you can always adjust the settings based on your specific trading time frame.
Usually, MACD is located at the bottom of your chart and just shows 2 lines crossing each other. In this case, we have the 12/26 EMA (dark line also known as MACD) and 9 EMA (light line). Then on the side you see a scale, with 0 in the middle. Obviously, below 0 is considered bearish and above is bullish.
Finally, we have what looks like a bunch of volume bars. The larger the volume bars; the more further apart the lines are to each other. If the bars are pointed below the 0 line, then the 12/26 EMA is below the 9 EMA, and the opposite is true if the bars are above the 0 line.
To make things really simple, just understand that MACD measures the difference between two EMAs.
- A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA.
- A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA.
Remember that when a the lower moving average is above the larger one that means the trend is more bullish.
Determining Bullish and Bearish Signals
In the following section we we will look at what certain actions indicate a bullish trend. Just remember that the opposite holds true for bearish signals.
Positive Divergence - Although this is most complex and rarest form of MACD, when it happens it is highly accurate. Basically, if the actual trend of the stock is down but the trend of MACD is up, then that is a good indicator that the actual trend is about to reverse and stock is ready to head higher. See example below
Bullish Moving Average Crossover – This occurs when MACD (12/26 EMA) moves above its 9-day EMA.
Bullish Centerline Crossover - As simple as it sounds, this just means when the MACD from negative to above the 0 into positive territory.
It is important to remember that entry/exit points should not be created solely on MACD, but can be highly accurate when used with other patterns and technical analysis indicators.
Below is a video that covers more about MACD and looks at an example.