What is MACD? How to Read MACD?

Moving Average Convergenc/Divergence ( MACD) indicator is an oscillator technique that uses 2 exponential moving averages. What makes this indicator so useful is that it combines some of the oscillator principles with a dual moving average crossover approach. MACD line is the difference between two exponentially smoothed moving averages of closing prices (usually the last 12 and 26 days or weeks).The signal line is usually a 9 period exponentially smoothed average of the MACD line.

The actual buy and sell signals are given when the two lines cross. A crossing by the MACD line above the slower signal line is a buy signal. A crossing by the MACD line below the signal line is a sell signal. An overbought condition is present when the lines are too far above the zero line. An oversold condition is present when the lines are too far below the zero line. The best signals are given when prices are well below the zero line (oversold).

Divergences appear between the trend of the MACD lines and the price line. A negative divergence exists when the MACD lines are well above the zero line (overbought) and start to weaken while prices continue to trend higher.That is often a warning of a market top. A positive divergence exists when the MACD ines are well below the zero line (oversold) and start to move up ahead of the price line. That is often an early sign of a market bottom.

MACD histogram

A histogram could be constructed  by plotting the difference between two moving average lines. Using the same technique, the two MACD lines can be turned into an MACD histogram. The histogram consists of vertical bars that show the difference between the two MACD lines. The histogram has a zero line of its own. When the MACD lines are in positive alignment, the hitogram is above its zero line. Crossings by the histogram above and below its zero line coincide with actual MACD crossover buy and sell signals.

The real value of the histogram is spotting when the spread between the tow lines is widening or narrowing. When the histogram is over its zero line (positive) but starts to fall toward the zero line, the uptrend is weakening. Conversely, when the histogram is below its zero line (negative) and starts to move upward toward the zero line, the downtrend is losing its momentum. Although no actual buy or sell signal is given until the histogram crosses its zero line, the histogram turns provide earlier warnings that the current trend is losing momentum. Turns in the histogram back toward the zero line always precede the actual corssover signals. Histogram turns are best used for spotting early exit signals from existing postions.

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