MACD, short for moving average convergence divergence, is a trading indicator used in technical analysis of stock price, Forex price, Share Price. It a trend-following momentum indicator that shows the relationship between two moving averages of a security's price. The MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.
The Formula for MACD:
MACD=12-Period EMA − 26-Period EMA
MACD is calculated by subtracting the long-term EMA (26 periods) from the short-term EMA (12 periods). An exponential moving average (EMA) is a type of moving average (MA) that places a greater weight and significance on the most recent data points. The exponential moving average is also referred to as the exponentially weighted moving average. An exponentially weighted moving average reacts more significantly to recent price changes than a simple moving average (SMA), which applies an equal weight to all observations in the period.
Mathematical interpretation
MACD series is a filtered measure of the derivative of the input series with respect to time. MACD estimates the derivative as if it were calculated and then filtered by the two low-pass filters in tandem, multiplied by a "gain" equal to the difference in their time constants. It also can be seen to approximate the derivative as if it were calculated and then filtered by a single low pass exponential filter (EMA) with time constant equal to the sum of time constants of the two filters, multiplied by the same gain.
Trading interpretation
Exponential moving averages highlight recent changes in a stock's price. By comparing EMAs of different lengths, the MACD series gauges changes in the trend of a stock. The difference between the MACD series and its average is claimed to reveal subtle shifts in the strength and direction of a stock's trend. It may be necessary to correlate the signals with the MACD to indicators like RSI power. Some traders attribute special significance to the MACD line crossing the signal line, or the MACD line crossing the zero axis. Significance is also attributed to disagreements between the MACD line or the difference line and the stock price.
KEY TAKEAWAYS
- MACD is calculated by subtracting the 26-period EMA from the 12-period EMA.
- MACD triggers technical signals when it crosses above (to buy) or below (to sell) its signal line.
- MACD helps investors understand whether the bullish or bearish movement in the price is strengthening or weakening.
- The speed of crossovers is also taken as a signal of a market is overbought or oversold.
Example of MACD Crossovers
As shown on the following chart, when the MACD falls below the signal line, it is a bearish signal which indicates that it may be time to sell. Conversely, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Some traders wait for a confirmed cross above the signal line before entering a position to reduce the chances of being "faked out" and entering a position too early. Crossovers are more reliable when they conform to the prevailing trend. If the MACD crosses above its signal line following a brief correction within a longer-term uptrend, it qualifies as bullish confirmation.
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