What is MACD (Moving Average Convergence/Divergence)?
The moving average convergence/divergence (MACD) is an important indicator developed by Gerald Appel in the 1970s. Using MACD, the investors can identify price trends and make their investment decisions accordingly.

This trend-following momentum indicator helps investors measure the momentum of the latest trend and determine the market entry and exit points for trading. MACD establishes the relationship between the price's two exponential moving averages (EMAs).

It is vital to measure the momentum and identify trends for trading success. Due to price fluctuations and market volatility, the traders find it challenging to determine the underlying trend. MACD indicator helps traders identify trends, calculate the momentum of trend drivers, and generate trading signals. 

Here, we will learn more about moving average convergence/divergence or MACD, how it works, the MACD strategies, limitations, etc.

What is MACD?

What is MACD?

MACD is one of the most popular technical indicators used by traders worldwide. This simple and flexible indicator helps traders identify trade entry and exit points. The traders use the same while buying or selling stock, bonds, commodities, etc. Using different strategies like histogram, zero-cross, crossover, relative vigor index, etc., calculate the difference between the 26-day and 12-day EMA of the security. Know more about Algo trading software.

While using the MACD, you must plot a nine-period EMA of the MACD, called the signal line. Use the line to trigger trading decisions when the MACD crosses. The signal is slower, while MACD is faster, as its points move more than the signal line.

What Does MACD Show?

The MACD line is generated when subtracting the 26-period EMA from the 12-period EMA. A nine-day MACD line EMA is called the signal line. The same can be found just above the MACD line. This point triggers whether to buy or sell signals. The traders may buy the asset when the MACD line crosses above the signal line. The traders can sell the security when the MACD line crosses below the signal line. 

How To Calculate MACD?

MACD Formula is mentioned below:

MACD = 12-Period EMA − 26-Period EMA

EMA is the exponential moving average with greater importance in the data points. To calculate MACD, you must deduct the long-term EMA of 26 periods from the short-term EMA of 12. An exponentially weighted moving average reacts much faster to stock price changes than a simple moving average or SMA.

How Does MACD Work?

When the 12-period EMA is higher than the 26-period EMA, the MACD has a positive value. When the 12-period EMA falls below the 26-period EMA, the MACD has a negative value. The level of MACD rising above or falling below the baseline reveals that the distance or gap between the two EMAs is widening.

MACD is usually represented with a histogram. It also shows the distance between MACD and the signal line. When the MACD is above the signal line, the histogram is also above the MACD or zero line. If MACD falls below the signal line, the histogram is below the MACD baseline. The traders use the histogram and determine whether a bullish or bearish momentum is possible. Options Trading App can also help you know more about it.

Types of MACD Strategies

Here, we discuss the types of moving average convergence/divergence strategies. 

1: Histogram

Many traders use the MACD histogram. MACS histogram plots the difference between the fast MACD line and the slow signal line. This strategy is used as a momentum indicator and jumps before the changes in the market.

There are different elements in the histogram:
  • The MACD line: This is calculated when a long-term EMA is deducted from a shorter EMA. 
  • The Signal Line: This line is produced when one EMA is deducted from the other. This creates a nine-day moving average. 
  • The histogram is produced when the signal line subtracts the MACD line. 
The traders use MACD histograms with other tools and techniques to determine their trade movements according to the market sentiment and stock trading volume.

2: Crossover Strategy

Another popular MACD strategy is the crossover. As the name suggests, the crossover in MACD happens when the signal and MACD line cross. This leads to a bullish signal by the MACD the moment it becomes higher than its nine-day EMA. Also, the line becomes bearish or triggers a sell signal when it falls below its EMA.

3: Zero-Cross Strategy

One of the strategies you must know while discussing MACD is the zero-cross strategy. When the MACD line crosses from below to above the zero line, it indicates a bullish signal. In this scenario, the traders take long positions.

When the line crosses from above to below the zero line, you must know it is a bearish signal. In this condition, the traders like to enter short positions. They try to benefit from the falling prices and a higher downward momentum.

It is also important to note that the signal will be more robust whenever there is a longer histogram bar. With a strong signal, the price will follow the trend.

4: Money Flow Index

This strategy, called the money flow index, helps traders use price and trading volume to know when the assets are overbought or oversold. This oscillator remains between the range of 0 and 100. When the point falls below 20, the assets are oversold, and for 80, it is overbought. Use Options Bot Templates to modify your personal trading strategy.

5: Relative Vigor Index

RVI, or the relative vigor index, is another common strategy. This momentum indicator determines the strength of the trend. It compares the trading range of an asset with its closing price using a simple moving average or SMA.

When the value of the RVI increases, it is a bullish trend. The traders believe this as the security closing price falls when the range reaches the higher end. Conversely, the opening price remains down at the range lower end.

6: Combines Strategy

Sometimes, traders combine the relative strength index (RSI) indicator strategy with SMA. Using the RSI, the traders can know the trend's strength while highlighting the trendline's reversal points. The same is mapped along a baseline of 14 periods in oversold and overbought levels.

The traders set the levels according to their unique strategies. The traders use SMA to find the average range of prices and determine whether a trend will continue in the same direction or reverse.

Combining these strategies helps traders forecast future price changes, find how strong a trend is, etc. Equity Trading Bot Template can help you develop trading strategies.

Limitations of MACD

Like any other technical indicator, even MACD has some drawbacks and risks.

One of the most important things is that a reversal signal does not always stand true. Imagine using zero-cross and see a point where the MACD crosses from below and again. When you enter a long position, you will be left with a losing stock if prices fall further. There are also false divergences when the security price moves sideways.

Also, the MACD fails to work in the sideways markets. When the prices move to the side and remain between support and resistance, MACD drifts toward the zero line due to the lack of an upward or downward trend. 

MACD zero-cross is not a helpful indicator as the price is above the previous low before the MACD crosses the line from below. This will need you to enter a long position later.

Wrapping Up

MACD is one of the most popular oscillators. This has proven to be a trustworthy way of identifying market trend momentum. There are many different strategies for trading MACD. Use Options Strategy Development and make your trading plan more effective. MACD is also considered a lagging indicator as the MACD uses the historical price action data. However, many traders use histograms to predict trend change, and they consider MACD a leading indicator of trend changes in the future.


What is MACD (Moving Average Convergence/Divergence)?
Aashutosh C 28 May, 2024
Share this post