The MACD Indicator which is the abbreviation for Moving Average Divergence Convergence is a momentum indicator tool that measures prices movement based on past events. The data displayed by MACD is data that had already occurred in the past. It is a technical indicator tool.
MACD indicator also shows the relationship between two moving averages, thus its formation. It is formed by subtracting the 26-period exponential moving average (EMA) from the 12-period exponential moving average (EMA). http://Investopedia.com
COMPONENTS OF MACD INDICATOR
MACD indicator is made up of four major components:
- MACD line which is the yellow line.
- Signal line which is the pink line and its a derivative of the MACD line, pricesly the 9-period exponential moving average (EMA).
- Histogram: the red and green bars.
- Zero line/ Center line that acts as a boundary between the histogram bars.
MACD Trading Strategy
MACD is a lagging indicator as it trails or follows the underlying asset. Using the MACD in trading involves Crossovers.
When the MACD line crosses from above to below the signal line, the trend changes to a downtrend and selling or shorting the trade will be considered and when it crosses from beneath to above, buying or longing the trade will be considered.
The value for the MACD is also considered when using the MACD indicator as technical analysis tool.
The value for the MACD line can be calculated by subtracting DEM from DIF. (See picture below)
When buying into a trade and the MACD value is positive, you can proceed to buy but if negative, you should rather short or sell the trade.
The histogram presented by MACD shows the strength of buyers and sellers.
When the MACD line crosses from above to below the signal line, the red bars (histogram) begins to form showing the strength of the sellers. Your market bias should be to sell or short the trade and vice versa.
Final note: whatever is presented on the MACD is likely to be presented on the EMA, so, the EMA can be used to confirm technical analysis done using the MACD.
You can watch our video on YouTube for better understanding.