The Moving Average Convergence Divergence or MACD Indicator is calculated by taking the difference between a shorter-term moving average and a longer-term moving average. The two most common are the 12 period moving average and the 26 period moving averages. Because of the way it is figured, the value of the indicator must equal zero when the two moving averages cross over each other. Because of this, a cross through the zero or center line can be a very simple method to identify the direction of the trend as well as key places when momentum might be building up.
The indicator can also be used to spot divergences. In other words, when the momentum isn’t in sync with the price action. For example, you may have a new high on the price chart, but the MACD is failing to make new highs. The histogram, or rows of bars on the indicator are often the most frequently used to find this information. The histogram is simply the difference of the moving averages being displayed in an easy to read format.
The idea of the MACD failing to make new highs can mean that the market is losing momentum, and that the highs might be from light volume. This is often a signal that a fall is about to happen. Of course, the divergence can be spotted in a down trend as well, only in opposite fashion.
Some traders will simply buy or sell depending on what side of the center line, or zero line the moving averages are. If they are below, they simply only sell, and if they are above, they only want to buy. Almost all traders use the MACD in conjunction with other indicators, as it is one of the most favored momentum indicators. However, it should be said that it struggles with range bound markets and shouldn’t be depended upon in those conditions. Because of a lack of momentum in those markets, the MACD can get a trader whipsawed.
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