The Moving Average Convergence/Divergence (MACD) is a technical indicator used to gauge the price momentum and trend. The MACD is composed of three indicators: the MACD line, the signal line and the histogram. The MACD line is calculated by subtracting a 26-period exponential moving average (EMA) from a 12-period EMA.
The signal line is a 9-period EMA of the MACD line, and it’s used with the MACD to gauge the trend direction when the two lines cross to the upside or downside. The histogram visually displays the magnitude of the distance between the MACD line and the signal line and it’s above a baseline when the lines cross to the upside and below the baseline when the lines cross to the downside.
The MACD indicator has many uses with the main one as a trend indicator. When the MACD line crosses the Signal line to the upside it can indicate the beginning of an uptrend momentum and when it crosses the Signal line to the downside it may signal the start of a downtrend momentum. See some examples in the chart below.
The other use you can notice in the chart above is how the histogram can signal overbought or oversold conditions when the two lines diverge too much. When the histogram rises well above the baseline the price momentum may fade a bit as it becomes overstretched and prone to a pullback. The same happens when the histogram goes way below the baseline.
As for any other indicator, it’s better to complement the MACD with other technical concepts or indicators to give you more structure and avoid false signals, especially in a rangebound market. For example, taking the previous chart, for a long trade you could use the previous swing level acting as support with a Fibonacci 38,2% retracement level as confluence. Then, you either wait for the MACD to confirm the end of the pullback and enter or you can wait more and enter on the next resistance breakout.
This article was written by Giuseppe Dellamotta.
