It is the combination of moving average in relation of an oscillator keeping intact the property of Moving Average. The MACD indicator is a lagging indicator and was created by Gerald Appel, which is based on exponential moving averages (EMA). The determination of trends and prediction of stock prices is one of the main tasks of the MACD (Moving Average Convergence Divergence). The idea behind to create indicator like MACD is to determine value generating possibility in terms of maximizing capital by making investment decisions in financial market based on the signals produced this indicator. The main goal is to identify the most proﬁtable parameters of the MACD as functions of investment strategy.
The advantage of application of this indicator is that it is equally useful for both the short-term and long-term oriented investors. Its calculation is based on the difference in the moving averages which makes it more like of a momentum indicator. The MACD helps traders forecast when to enter or exit a trade. This indicator can also be used to determine when a trend may be reversing.
The MACD indicator is constructed by subtraction of the 26-days’ exponential moving average from the 12-days’ exponential moving average. From the MACD indicator that has been obtained in this way, the 9-days’ exponential moving average is calculated as a signal line. The shorter 12-days’ exponential moving average is closer to the movement of the stock price and is more sensitive to changes of trends than the longer, 26-days’ moving average
MACD line = (12-day exponential moving average of prices) - (26-day exponential moving average of prices)
Signal line = 9-day exponential moving average of MACD values
The MACD line is the faster one and it generates trading signals by crossing the signal line.
If the MACD line crosses above the signal line, it implies a buy signal. A sell signal occurs when the MACD line crosses under the signal line.
Besides, if the MACD line crosses above zero, it yields a buy signal. Conversely, if the MACD line crosses under zero, it is considered a sell signal.
A lot of trader uses this indicator but not everybody is aware of how to use it most effectively. However, there is a better approach of trading on MACD which generally is not being informed to traders. This MACD indicator is basically fluctuates between a centre line which is called a zero line. This type of indicator helps us in identifying strength and weakness of the trend. This Indicator has three important things which we have to look into. First is MACD Line which we also call as faster moving line, then there is a signal line which is known as slower moving line and finally the histogram which is formed vertically and inversely above or below zero line. So ideally, what as trader we have to look after the crossover of MACD line and signal line, is the movement of signal line into positive zone and negative zone. If the indicator is above zero line is bullish mode and if the indicator is below zero line is called bearish mode.
If after the positive crossover for the buy signal, the signal line goes above the zero line, it implies a buy signal. Now an important thing here is to observe that until this signal despite after a bearish crossover of MACD & Signal line above Zero line, doesn’t actually imply a short sell signal. The reason here is that until signal line stays above the Zero line the trend of the stock is likely to remain bullish. So an ideal way of trading on this MACD indicator is to book profit from our long trade when we see a bearish crossover into positive zone and look for further buying opportunity till this signal line stays above this Zero line.
Once, this signal line starts dropping below this centre line or Zero line then we can look for a short sell signal or we can change our view that trend of the stock has here reversed and now we have to look for short sell trade and same idea we have to apply for our short sell trade the way we had looked into when we were into long side trade. So the function of the MACD indicator is to tell when the trading the momentum is going to change from being bullish to bearish and from bearish to bullish.
The role of histogram in MACD is to show the strength in that trend. If the histogram is forming in increasing trend it signals that trend is strong and if the histogram starts forming in descending way signals the reversal of the trend or the weakening of the trend. If there is no histogram it shows there is no trend or it’s a range bound market. So MACD is one of the most preferred indicators because of its capacity to show the trend more explicitly and no wonder why it is so famous among the traders and chartists.