The Moving Average Convergence Divergence,
or MACD, is a momentum indicator that shows the relationship between two moving averages. Investors can use this indicator to measure
a stock's momentum and determine its trend. In this video, we'll show examples for how
the MACD is calculated, identify potential buy and sell signals, and discuss the potential
benefits and risks of using this indicator. At its most basic level, the MACD indicator
tracks the difference between a fast-moving average and a slow-moving average. Investors can adjust the duration of these
moving averages, but many commonly use the 12-day as a fast-moving average and the 26-day
as a slow-moving average. In other words, the MACD subtracts the 26-day
moving average from the 12-day moving average. Investors can use this information to help
define trends, or they can take it a step further and use the indicator when applying
the signal line.
The signal line is a faster moving average
that crosses above or below the MACD. Typically, a 9-day moving average is used
as a signal line. Investors may use the signal line to help
identify crossovers, which then helps them pinpoint potential buy and sell signals. A crossover occurs when the MACD crosses above
or below the signal line. A bullish crossover occurs when the MACD crosses
above the signal line. Some investors may consider this a buy signal. On the flip side, a bearish crossover occurs
when the MACD crosses below the signal line. Some investors may consider this a sell signal.
In addition to the signal line, the MACD indicator
has a histogram, which investors can also use to identify crossovers. The histogram plots the signal line from a
different perspective. For example, if the signal line is trending
down, the histogram plots a negative value. But as soon as the signal line turns higher,
the histogram displays a crossover and plots a positive value. So, when the histogram goes from negative
to positive, it coincides with the MACD crossing above the signal line. Now that we've discussed how to calculate
the MACD and how to consider using it to identify potential buy and sell signals and crossovers,
let's look at an example of how you can use the MACD to help inform trading decisions. Suppose an investor identifies a crossover
in the MACD above the signal line and buys a stock. Once in the trade, she'll monitor the MACD
and signal line and stay in the position as long as the indicator is trending higher.
When the MACD crosses below the signal line,
she could then exit the trade. Keep in mind this is just an example of how
the MACD can help an investor identify potential buy and sell signals. It doesn't always work this well. Investors commonly experience frequent whipsaws
when using the MACD. A whipsaw occurs when the MACD gives a buy
signal, and then a stock quickly reverses lower and the MACD gives a sell signal.
The MACD can also be late in identifying buy
and sell signals because it relies on moving averages that use historical data. This can cause a lag between the current stock
price and a buy signal in the indicator. Because of these drawbacks, investors often
wait for additional confirmation before entering trades based on crossovers. That's why savvy investors combine the MACD
with other forms of analysis to confirm buy and sell signals.