The MACD Indicator

Overview

• MACD (Moving Average Convergence Divergence): A trading indicator used to measure a stock’s momentum and identify potential entry/exit points.
• Type: Lower indicator (appears as a separate chart below a stock chart).
• Components: MACD line, Signal line, Histogram.

MACD Line

• Oscillator: Centers on zero line.
• Above Zero Line: Indicates upward momentum.
• Below Zero Line: Indicates downward momentum.
• Calculation: Distance between 12-day EMA (short-term) and 26-day EMA (long-term).
• Signal:
  • Crosses Above Zero Line: 12-day EMA > 26-day EMA, bullish signal.
  • Crosses Below Zero Line: 12-day EMA < 26-day EMA, bearish signal.

Signal Line

• Definition: 9-day EMA of the MACD line.
• Purpose: Provides a more precise view of momentum changes and potential trend reversals.
• Signal:
  • Bullish Crossover: MACD crosses above signal line, considered as a buy signal.
  • Bearish Crossover: MACD crosses below signal line, considered as a sell signal.

Histogram

• Function: Plots the difference between MACD and Signal line as bars.
• Zero Value: MACD = Signal line.
• Negative Value: MACD < Signal line.
• Positive Value: MACD > Signal line.
• Usage: Helps identify crossovers early.
  • Example: Rising histogram may signal early entry for a buy; falling histogram may signal early exit.

Drawbacks of MACD

• Whipsaws: Frequent contradictory signals.
• Lag: Relies on historical data, causing delays in signals.

Supplementary Tools

• Recommended Confirmations: Trendlines, divergences, candlestick charts.
• Purpose: Providing a more comprehensive picture and avoiding drawbacks.

Conclusion

• MACD Usage: Helps in making informed trading decisions but should be used with other tools for confirmation to avoid drawbacks like whipsaws and signal lags.