MACD

MACD

Its been long time since I posted any tutorial. MACD (Moving Average Convergence-Divergence) post has been in work for past 2-3 weeks and other post took precedence due to very dynamic moves in the markets but I will feel guilty to delay it any further.

We have already seen Moving Averages which are trend following Indicators. We have seen RSI which is an Oscillator. Both have their own advantages and downside. MACD, to start with, you can say combines best of both Worlds. MACD takes two trend following Indicators (Moving Averages) and turns them into an Oscillator. MACD gives us valuable information about not only the trend but also the momentum (strength) in the direction of the change. Before deliberating further, let us see how MACD is defined and constructed.

MACD consists of three components usually defined as MACD (12, 26, 9) which is most popular combination. 12 and 26 here depicts that MACD is using Exponential Moving Average of 12 duration and 26 duration (Days, Weeks or Months) for calculating MACD Line. Third letter, 9 indicates Exponential Moving Average of MACD Line for 9 duration which is used as Signal Line. MACD Line is calculated as 12 EMA Value - 26 EMA Value and Signal Line is calculated as 9 EMA of MACD Line. Histogram that you see with MACD is the difference between MACD Line and Signal Line. The centerline around which MACD Line oscillates is also called as zero line. You can use other durations for constructing MACD depending on your time horizon and sensitivity requirements. Please see the MACD in the chart below to familiarize yourself with above terms.

Reading MACD

Let us now see how exactly we get information from MACD. As per above formula if 12 EMA (which is faster, more responsive) is higher than 26 EMA, the MACD Line is in positive territory. Positive value increases when 12 EMA is increasing at a faster speed with respect to 26 EMA which also indicates that the positive momentum is increasing. Similarly when negative value increases, it means that 12 EMA is lesser than 26 EMA and the difference is increasing indicating a stronger negative momentum. This is the most basic reading of MACD.

MACD Signals

Traders use MACD is varieties of ways to identify trading signals. Some of the popular MACD Signals are listed below;

• Signal Line Crossovers
• Centerline Crossovers
• Divergence

I will make another post to explain each of the above strategy in details and with examples.

In a nutshell

MACD has the unique advantage of identifying trend as well as strength (momentum). Unlike RSI, MACD does not help in identifying overbought or oversold conditions and it does not have any upper or lower levels which limit its movement. Since MACD is a difference between two EMAs, its value depends on value of the underlying and it may totally differ for a stock worth 10 Rs or for NIFTY at 5700 level. Hence don't compare MACD of two different scripts or underlying with each other. Also, we can use different durations of EMA to change the sensitivity of MACD e.g. MACD (5, 31, 5) would be more sensitive than MACD (12, 26, 9). I prefer to go with the standard used format of (12, 26, 9). Never felt the need to try any other combo.

Now, after completing this post, I am feeling a lot better and lot lighter. Will quickly complete the follow-up post on MACD Signals with more graphs and little commentary to close this chapter. As usual, will lover to know what you think of the post so go on and let me know. Happy Trading.