Interpreting the MACD Indicator

Apurva Sheth
We have seen that moving averages can be used in many ways by traders. A common application of moving average is to generate buy/sell signal. A buy signal is generated when the price moves above the average. A sell signal is generated when price moves below average. This is the most basic way of using moving average.

Some traders take it one step forward and use a combination of two moving averages. They use two moving averages (short and long) to generate signals. A buy signal is generated when shorter average crosses above the longer. A sell signal is generated when shorter average crosses below the longer.

Identifying crossover can be difficult at times as both the averages tend to move along very close to each other with the price action. To make traders lives simpler, Gerald Appel developed Moving Average Convergence Divergence or MACD indicator in 1970’s. He preferred using 12 as the shorter average and 26 as longer average. These are the most commonly used parameters while plotting MACD. I have introduced this indicator in one of my earlier article on moving average crossovers.

MACD is nothing but the shorter moving average (12) minus the longer moving average (26) . Traders can choose any type of moving average simple or exponential as per their preference. (I have used exponential moving average (EMA) in all the examples below.) A running total of 12 EMA minus 26 EMA is plotted below the price as an indicator. When the 12 EMA is trading above the 26 EMA MACD will be positive. When the 12 EMA is trading below the 26 EMA MACD will be negative.

Let us see the various ways in which we can use MACD.

  1. Centerline Crossover

    A centerline bifurcates positive MACD value from negative ones. When the MACD shifts from negative to positive zone it is termed as bullish centerline crossovers. When it shifts from positive to negative zone it is termed as bearish centerline crossovers. Simply put a centerline crossover is nothing but a moving average crossover presented in a visually appealing way.

    Centerline crossover in Bharti
    Source: Spider Software India

    In the above picture I have illustrated centerline crossovers on the daily chart of Bharti Airtel. I have plotted the 12 EMA in orange and 26 EMA in green. You can notice that whenever the orange line or 12 EMA crosses below the 26 EMA or green line the MACD crosses the centerline and enters the negative territory. On the other hand whenever it crosses above the 26 EMA the MACD enters the positive territory. There are 5 signals generated in all. Out of these 4 have worked well.

  2. Signal line Crossover

    A signal line helps to identify turns in the MACD. A moving average is plotted on the MACD to identify turns in it. A 9 period average is commonly used to generate a signal line crossover on the MACD. When the MACD crosses above the signal line it is termed as a bullish signal line crossover. When it crosses below the signal line it is termed as a bearish signal line crossover. A bearish crossover occurs when the MACD turns down and crosses below the signal line.

    Signal Line crossover in BPCL
    Source: Spider Software India

    In the above picture I have illustrated signal line crossovers on the daily chart of BPCL. I have plotted the MACD indicator with its 9 day EMA in the panel below price. The green line in this panel is the MACD and the red line is the 9 EMA of MACD or the signal line. A bullish signal line crossover occurs when the green line or MACD crosses above the red line or signal line. There were 3 bullish signal line crossovers. All of them worked quite well. A bearish signal line crossover occurs when the green line or MACD crosses below the red line or signal line. There were 4 bearish signal line crossovers. The first two sell signals didn’t work well as the stock didn’t move substantially lower after giving the sell signal. Some traders work around this by taking sell signals only when the MACD is negative and buy signals only when the MACD is positive.

  3. Divergences with Price

    MACD and price moves in tandem with each other most of the time. However, there are instances when both of them diverge. Such divergences can act as warning signs of a trend reversal in near future. One can look out for bullish and bearish divergence. A bullish divergences is formed when price forms a lower low but MACD forms a higher low. A bearish divergence is formed when price forms a higher high but MACD forms a lower high. Divergences signal that the current trend is exhausting and a change in trend is possible.

    MACD Divergences in Nifty
    Source: Spider Software India

    In the above picture I have illustrated bullish and bearish divergences occurring in Nifty. The first marking in the left of this chart in red is an example of a bearish divergence. Here Nifty hit a higher high but the MACD failed to hit a higher high. This indicated that the uptrend could be nearing an exhaustion. The second one marked in green is an example of bullish divergence. The Nifty hit a lower low but the MACD formed a higher low. MACD was also way higher compared to the low it hit a few months ago. This indicated that a change in trend could be possible.
Do you use MACD indicator in your trading and investments? Share your views in the Club or share your comments here.

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7 Responses to "Interpreting the MACD Indicator"
Arun
21 Aug, 2018
Very apt, keep it up.Like 
Ajay
19 Jul, 2015
I am following your posts very carefully but confused about your stop loss entering. secondly here about the Nifty example is not clear. I would like to know your chARting software, if possible?Like 
Krishan Chander Anand
18 Jul, 2015
It is a good write up understandable to the lay person. Keep it up so that you can win the confidence of the members.Like 
Ujwal
05 Jul, 2015
What is the rational behind 9, 12 & 26 periods taken in MACD? Like 
shailesh
27 Jun, 2015
Dear Apurva Is the central line cross over and signal line cross over same. I am a bit confused.If 12 SMA or EMA crosses 26 SMA/EMA - Is it central line cross over. And how do we define the signal line cross over in similar terms regardsLike 
ARUP
25 Jun, 2015
I'm following your Posts from the beginning ... you are steadily taking the teaching ahead very well ..the examples are really helpfull to grasp the concept...! Will be eagerly awaiting many such posts ...!! Like 
Dattatraya Vaidya
24 Jun, 2015
Which charting software do you use. Are there any charting sites, free of charge.Like (1)
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