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Convergence or Divergence, all technical indicators must be in coherence with one another. Moving Averages form the basis of yet another powerful tool - Moving Average Convergence and Divergence or MACD. This is so powerful and essential that nearly all traders rely on MACD as one of their primary indicators.
MACD uses EMA (Exponential Moving Average) to pictorially represent the direction of price movement. Generally denoted by MACD(a,b,c); the parentheses have 3 values of time periods for calculation of MACD. It uses a fast EMA (a) and a slow EMA (b) to direct traders to place their bets. The most common is MACD (12,26,9).
MACD is a kind of price oscillator, as its value changes with the change in price. There are 3 kinds of price oscillator:
MACD is part of the APO family as it deals with absolute prices. PPO is preferred when different securities are compared or when the same security is compared at significantly different time frames having large differences in prices, and therefore normalization is helpful.
There are 3 components of MACD:
As all the steps involve using of EMA or already calculated indicator, MACD is also referred to as the indicator of indicators.
Stage 1: EMA (a) & EMA (b)
Stage 2: MACD = EMA of [EMA (a) - EMA (b)]
Stage 3: Signal line = EMA (c) of MACD
Stage 4: Histogram = MACD - Signal
Zero Crossover (MACD crossover with respect to centreline or horizontal X-axis):
Since MACD is the difference between Fast EMA & Slow EMA, it can be broadly said that when MACD is above zero it is an uptrend and when MACD is below zero it is a downtrend. In the case of an uptrend, go for longing and in a downtrend, go for shorting. Moving from below to above the centreline can be considered as bullish and from above to below can be considered as bearish.
Signal Line Crossover (MACD crossover with respect to MACD signal line)
It is often considered that when a stock (or crypto) accelerates in the direction of the crossover, there are two types of possibilities:
Convergence and Divergence
It is called MACD (Moving Average Convergence & Divergence) as we have to first identify convergence in Histogram (loss of momentum) which will be automatically followed by divergence (on the opposite side) accompanied by a gain of momentum.
There are two types of divergences:
Bullish Divergence or Positive Divergence:
When MACD or price action makes lower low and histogram makes a higher low.
Bearish Divergence or Negative Divergence:
When MACD or the price action makes a higher high but the histogram makes a lower high.
Most commonly used APO (Absolute Price Oscillator) MACD:
PPO (Percentage Price Oscillator) MACD:
MACD = Moving Average Convergence and Divergence
EMA (n) = Exponential Moving Average (Time Period ‘n’)
MACD being a lagging indicator is not that useful for securities trading with erratic price action.
The PPO is prone to providing false crossover signals, both in terms of signal line crossovers and centerline crossovers. Assume the price is rising, but then moves sideways. The two EMAs will converge during the sideways period, likely resulting in a signal line crossover and potentially a centerline crossover. Yet the price hasn't actually reversed or changed direction, it just paused.
The indicator is also used to spot divergences, which may foreshadow a price reversal. Yet divergence is not a timing signal. It can last a long time, and won't always result in a price reversal.
The indicator is composed of the distance between two EMAs (the PPO), and an EMA of the PPO (signal line). There is nothing inherently predictive in these calculations. They are showing what has occurred, and not necessarily what will happen in the future.
1. Generally MACD (12,26,9) is used
2. Look for MACD crossover with respect to 0 line or horizontal x axis
3. Histogram crossover with respect to 0 line or horizontal x axis
4. Convergence (of the histogram), followed by divergence
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