What is the MACD indicator and how to interpret it?
When speculating on the financial and stock markets, it is necessary to know the best indicators used in the framework of technical analysis of charts. Among the most popular of these indicators, the MACD or Moving Average Convergence Divergence is very widespread and used by many private and institutional traders to obtain reliable speculation signals.
Presentation of the MACD
MACD stands for Moving Average Convergence Divergence, which in Spanish literally means a moving average convergence and divergence indicator. Allows for precise analysis of exponential moving averages.
To work, the MACD uses the difference between two exponential moving averages or EMA based on the closing prices of an asset. In this case, what is interesting is the moving average of this difference.
The essential thing is to use only the closing prices to apply this method of analysis, originally created to compare 26-day and 12-day moving averages.
Like most technical indicators, the MACD is represented visually, on a chart. There are two types of display and, consequently, different representations of these indicators:
The first is a representation in the form of a curve that is generally used for medium and long-term analyses.
The second method is a representation in the form of a histogram and is more specifically used for short-term analysis.
Some operators use these two types of visualization simultaneously, but if they want to use this method, they must take into account the scales, since they differ from one to the other method.
Thanks to its graphical representation, the MACD is an excellent trend indicator. It has the advantage of being based on moving means, thus making its interpretation more accurate and reliable.
How is the MACD calculated?
To determine the MACD, you need to use the difference between two exponential moving averages. But this calculation method is rather simple to understand. In this calculation, the last closing price will have more importance than the other prices of the same period, but what varies is the level of this importance depending on the exponential percentage used.
Every time a new close takes place, it tries to make the difference between the exponential moving averages of two different durations. The result thus obtained is then used to calculate the last 8 closing prices in order to perform a kind of 9-day exponential moving average on the differences between the exponential moving averages of the two durations used.
How to use the MACD in the framework of speculation
The MACD is a choice indicator for online speculation. However, there are several ways to interpret it.
The first method is to identify the crossovers between the MACD curve and the signal line. When the MACD curve goes below the signal line, this induces a bearish indication. Conversely, when the MACD goes above the signal line, this evokes a bullish signal. When the crosses occur in the areas called overbought or oversold, they are considered more reliable indicators than others.
The other interpretation technique uses this time the divergences between the evolution of the prices and the MACD. Clearly, it is about identifying the moments in which the MACD curve will evolve in opposition to the signal line.
Crosses and divergences of the MACD and its interpretation
As we have just seen in detail, the MACD can be a high-quality technical indicator as long as the trader using it understands it and interprets it consistently. Currently, there are two main methods to use this indicator effectively in trading, namely detecting signal line crossovers and MACD trend/price line divergences. The following explains how to use these two chart elements.
Interpretation of MACD crossovers: To detect them, it is necessary to associate another line called the signal line to the MACD line, which is derived from a shorter Exponential Moving Average. Thus, when the MACD line crosses this signal line, either up or down, we get a buy or sell signal. Traders often refer to this method as the crossover or crossover method.
Regarding the interpretation of the divergences, here the divergences between the MACD and the actual price of the asset are used. These divergences make it possible to identify a slowdown in the trend and therefore effectively anticipate an upcoming trend reversal or radical change. Of course, the stronger the divergence, the more important the reversal signal will be.
What are the advantages and disadvantages of MACD?
As is often the case with all technical indicators that you can use on the trading platform, the MACD has different advantages and disadvantages, which we suggest you discover in more detail here before putting this analysis into practice within your trading strategy.
Let's start by talking about the many advantages of this MACD indicator. The main advantage of this indicator compared to other trend indicators is that it can be extremely reactive. In this way, the MACD is almost always able to quickly discover the most important trend changes, and it is this reactivity that makes it a very popular indicator in the world of trading since investors often prefer it to indicators that are based on classical moving averages. Thus, the fact that the MACD uses an exponential average that allows accentuating the differences makes this indicator advantageous, since it allows you to identify interesting movements quickly and at a glance.
However, the MACD also has some flaws and limits. We can talk about early detection and forecasting, which some may consider an advantage but others consider it a defect. Indeed, we know that the earliest indications are often also those with the greatest risk of errors.
Furthermore, while the MACD is an advantage in terms of speed of analysis, this large margin of error is its main weakness and can present a significant risk to the investor. That is why we advise you to use the MACD only in addition to another technical indicator that allows you to decide if the signals obtained are really reliable or not.
Among the flaws of the MACD we can also mention the fact that, like all technical indicators, it does not take into account all the MACD in stock prices of an asset, but only some of the recent prices that it is analyzing at that moment. The MACD does not focus on the past prices of that asset, and therefore only bases its predictions on the correlation of the prices of the asset between them in the period studied. Care must be taken because this correlation is highly variable and may also present some risks.