How the MACD indicator works.

What is the MACD indicator?

The Moving Average Convergence Divergence (MACD) indicator consists of a mathematical formula. It's calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. The result is the MACD line. A 9-day EMA is added to the MACD as a "signal line." The MACD provides traders with signals for possible short term bullish or bearish trends. Crossovers and divergences are used to identify possible trend continuations or reversals.


source: Thinkorswim (click to enlarge)



What is a MACD crossover?

For the signal to be effective, there has to be a convergence (crossover) with the MACD and the signal line. The signal line serves as a trigger to buy or sell. When the MACD crosses above the signal line it signals a buy. On the other hand, when it crosses below the signal line it signifies a sell or sell-short signal.


source: Thinkorswim (click to enlarge)



What else does the MACD indicator provide?

The MACD also includes a histogram. The histogram is a baseline (0-line), which helps traders identify the stock's momentum strength. Traders can determine the strength based on the MACD and Signal Line's separation from each other. The greater the distance between the MACD and the Signal Line, the stronger the momentum. If the momentum is bullish, the histogram will graph above the baseline. If the momentum is bearish, the histogram will graph below the baseline. It is essential to know that the histograms red and green bars show the distance between the MACD and its Signal Line.


source: Thinkorswim (click to enlarge)



What about using divergence?

Divergence is another way the MACD helps identify possible trend reversal. Divergence is when the price in a particular stock is trending in the opposite direction when compared to the MACD indicator. For example, if a stock price is in a downtrend, but the MACD moves upwards, it creates divergence from the price action. Since the MACD is moving upwards it is considered a bullish divergence. It is important to note that the divergence strategy is not as reliable as the crossover.


source: Thinkorswim (click to enlarge)



How useful is the MACD?

The MACD is one of the most popular indicators for traders since it's inception. Most traders use it along with the Relative Strength Index (RSI) to better understand a stock's overall momentum. We will discuss the RSI in the following newsletter.



**Pennystocksclub13 (psc13.com) is in no way affiliated with thinkorswim. Charts are used for educational purposes and in no way, promote or discourage the use of thinkorswim and its parent companies.




Disclaimer: Results may not be typical and may vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk!


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