MACD

Two averages, one story

MACD (say "mac-dee") stands for Moving Average Convergence Divergence. Big name, simple idea. Converge means come together. Diverge means move apart. MACD watches the gap between two moving averages as they come together and move apart. Gerald Appel created it in the late 1970s.

It uses two EMAs: a fast 12-day EMA and a slow 26-day EMA.

The three parts

1. MACD line = 12-day EMA minus 26-day EMA.
2. Signal line = a 9-day EMA of the MACD line. It's a slower copy that follows behind.
3. Histogram = MACD line minus signal line, drawn as little bars.

That's what the standard setting 12, 26, 9 means.

Work one out

Say the 12-day EMA is $52 and the 26-day EMA is $50.

• MACD line = 52 - 50 = +2. Positive means recent prices are above the longer-run average.

Now say the signal line is at 1.5.

• Histogram = 2 - 1.5 = +0.5. A small bar above zero.

Tomorrow prices rise more. The 12-day EMA becomes $54 and the 26-day becomes $51.

• MACD line = 54 - 51 = +3. The gap between the averages grew, so the upward push is getting stronger.

How traders read it

• Above or below zero. When the MACD line is above zero, the fast average is above the slow one, just like a crossover. Below zero, the fast one is below.
• Signal line crosses. The MACD line crossing above its signal line hints that momentum is turning up. Crossing below hints it's turning down.
• The histogram. Taller bars mean momentum is growing. Shrinking bars mean the push is fading, even if price is still rising. That's often one of the first things to change near a top, which is why many traders watch the histogram closely.

Where it fails

MACD is built from averages, and its signal line is an average of that, so it lags even more than a plain moving average. By the time the lines cross, much of the move can be over.

In sideways markets, the lines tangle around zero and cross again and again, giving signal after signal that goes nowhere.

And MACD has no top or bottom, unlike RSI's 0 to 100. There's no fixed "overbought" number. A reading of +3 might be huge for a $20 stock and tiny for a $2,000 stock.

Remember

• MACD line = 12 EMA minus 26 EMA. Signal line = 9 EMA of the MACD line. Histogram = the gap between them.
• Above zero means the fast average is above the slow one.
• Shrinking histogram bars mean momentum is fading.
• MACD is slow and gives lots of false crosses in sideways markets.