What Is MACD? - Moving Average Convergence/Divergence - Fidelity (2024)

FAQs

What Is MACD? - Moving Average Convergence/Divergence - Fidelity? ›

The Moving Average Convergence/Divergence (MACD) indicator shows the relationship between 2 moving averages of prices. MACD is derived by dividing one moving average by another. It is based on the point spread difference between 2 exponential moving averages of the closing price.

Moving average convergence/divergence (MACD) is a technical indicator to help investors identify market entry points for buying or selling. The MACD line is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The signal line is a nine-period EMA of the MACD line.

The histogram is positive when the MACD line is above its signal line and negative when the MACD line is below its signal line. The values of 12, 26, and 9 are the typical settings used with the MACD, though other values can be substituted depending on your trading style and goals.

MACD is a trend-following momentum indicator that shows the relationship between two moving averages of a security's price. Traders use the MACD to identify entry and exit points for trades. MACD is used by technical traders in stock, bond, commodities, and FX markets.

The MACD displays moving averages and a histogram to identify trends and measure their momentum. Divergence between prices and the MACD indicator provide the strongest indications for trend reversals.

For daily charts, many traders find the default MACD settings (12, 26, 9) to be very effective. This timeframe captures the broader market trends and helps filter out market noise. Combine MACD with other indicators like RSI or Bollinger Bands when analyzing a 1-day chart for a more comprehensive market view.

MACD crossing above zero is considered bullish, while crossing below zero is bearish. Secondly, when MACD turns up from below zero it is considered bullish. When it turns down from above zero it is considered bearish.

The best way to trade moving average is to use the crossover strategy, where a shorter-period moving average crossing above a longer-period moving average generates a bullish signal, and vice versa for a bearish signal. This method helps indicate potential changes in the market trend.

The strongest divergences are Class A divergences; exhibiting less strength are Class B divergences, and the weakest divergences are Class C. The best trading opportunities are indicated by Class A divergences, while Class B and C divergences represent choppy market action and should generally be ignored.

The MACD is calculated by subtracting the 26-period (7.5%) exponential moving average from the 12-period (15%) moving average. The nine-period (20%) exponential moving average of the MACD line is used as the "signal" line.

How to avoid MACD false signals? ›

Increasing the number of periods for the signal line will reduce the number of crossover signals, helping avoid false signals. However, trade signals will occur later than they would with a shorter signal line EMA. The indicator can be applied to any timeframe, but it's preferable to choose those from H1 and bigger.

Short-term buy-and-sell signals are generated by the MACD line and the signal line. If the MACD line crosses above the signal line, this may be interpreted as a buy signal. Alternatively, if the MACD line crosses below the signal line, this may be interpreted as a sell signal.

While the MACD has many strengths and can help traders spot trend reversals, it is not infallible and struggles, particularly in sideways markets. Since the MACD is based on underlying price points, overbought and oversold signals are not as effective as a pure volume-based oscillator.

Drawbacks of MACD

Traders should be aware that the whipsaw effect can be severe in both trending and range-bound markets because relatively small movements can cause the indicator to change directions quickly. A large number of false signals can result in a trader taking many losses.

Strong trend: When the market is in a strong trend, the MACD may lag behind the price action and generate signals too late. Traders may want to use other indicators, such as the Relative Strength Index (RSI) or the Stochastic Oscillator, to complement the MACD in these situations.

MACD with PRC has a 90% success rate. A stock's moving averages should at least approach one another, if not cross, before you act on that stock. MACDs rely on three exponential moving averages instead of one or two. Look for patterns where the three moving averages come together closely.

The MACD strategy in its most basic form involves using the crossing of the smoothed out signal line over the MACD line as your entry or exit point for a trade. The MACD works best when used in conjunction with support and resistance and moving averages as MACD cues often fail, especially in choppy market conditions.

Simple MACD strategy

With this strategy, the orders are opened as follows: If the MACD histogram crosses the moving average upwards, the buy order will be placed. If the MACD histogram crosses the moving average downwards, the sell order will be placed.

The 12 represents a moving average of the previous 12 bars. The 26 represents a moving average of the previous 26 bars. The 9 represents a moving average of the difference between the two moving averages above.

One of the main problems with divergence is that it often signals a (possible) reversal but no actual reversal occurs—a false positive. The other problem is that divergence doesn't forecast all reversals. In other words, it predicts too many reversals that don't occur and not enough real price reversals.