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<\/p>\nThe MACD indicator is one of the most popular tools in technical analysis, and it\u2019s another tool that we occasionally use in our reports.<\/p>\n
Developed by Gerard Appel in the 1960s, the basic idea of MACD histogram is to follow the trend in the market under consideration, with a special hybrid of two different moving averages.<\/p>\n
We take two exponential moving averages (typically with periods 12 and 26) and subtract the slower (26 period) from the faster (12 periods) to get the \u201cMACD line\u201d, given in blue in the chart below.<\/p>\n
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Observe that in this market the faster (brown) moving average is always higher than the slower (pink) moving average, so that the MACD line is always positive.<\/p>\n
When the moving averages are closest together, MACD is at its lowest level. As the moving averages get further apart, MACD rises accordingly. And since the faster (brown, 12-day) moving average is always greater than the slower (blue, 26-day) moving average, MACD \u2013 the latter subtracted from the former – is always greater than zero.<\/p>\n
So what\u2019s the red line beside the MACD line? That\u2019s the Trigger <\/em>or Signal <\/em>line, and is the 9-period exponential moving average of the MACD line. That makes it the average of a difference between two averages!<\/p>\n The red line provides us with a handy way to interpret MACD, providing easily recognised buy and sell signals. For example, a trader could take a buy signal whenever the MACD line crosses the signal line from below, or a sell signal whenever it crosses from above. This is really just a more advanced version of taking buy and sell signals whenever moving averages of different periods intersect with each other.<\/p>\n To help isolate the distance between MACD and the signal line, some people plot this distance as a histogram along with the line, like this:<\/p>\n With the histogram in place, we can spot the buy and sell signals whenever it crosses from positive to negative, or vice versa. We can also get early warnings of the signal as we watch the histogram reach highs and lows. When it reaches a high, and starts declining, we know that the sell signal is getting closer; when it forms a low, and starts rising, we know that a buy signal is imminent.<\/p>\n Another way to use MACD is to look for any divergence <\/em>it has with the price action. This helps us to identify situations where a trend is running out steam \u2013 where the price is continuing to move in the direction of the trend, but without the conviction it had before. This principle provides us with early clues of a reversal.<\/p>\n Above is an example of a reversing bull market where the price reached a higher high, but the falling MACD line hinted that all was not well.<\/p>\n As a word of warning, here\u2019s an example of a ranging market where the choppiness means that getting useful buy or sell signals is impossible. In this case we\u2019ve placed the Buy and Sell signals on the days after <\/em>MACD and the trigger actually intersected, to give a more realistic \u201cworst case\u201d scenario, where we don\u2019t get to execute our trade until the signal is confirmed on a closing basis. As you can see, the results aren\u2019t impressive:<\/p>\n As with everything else, the MACD is not a cure-all. As a trend-following indicator though, it is certainly a useful tool and helps to place any market in a bullish\/bearish context, as well as providing us with interesting signals. Whether we are looking for specific crossover trade signals, or just watching how elevated or depressed the MACD line is to tell us how bullish or bearish the market is, it\u2019s something that\u2019s worth keeping an eye on in a wide variety of situations.<\/p>\n Some principles to bear in mind here and with indicators in general:<\/p>\n![](\"http:\/\/futurestechs.co.uk\/media\/images\/MACD2.bmp\")
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