Moving Average Convergence Divergence (MACD)
Updated on March 7, 2023
Moving Average Convergence Divergence or MACD was developed by Gerald Appel in the 1970s and is one of the most popular and known momentum indicators used in technical analysis. It is a tool used by traders to understand the direction of momentum and its strength.
The calculation of MACD involves measuring the difference between two time periods which are basically a collection of time series data. One of these time periods should be of shorter time period and the other should be of longer time period.
Generally, exponential moving averages (EMA) are considered for this purpose. The ‘moving averages’ of two separate time intervals are used, which typically consist of closing prices of a stock. A momentum oscillator line is drawn using these moving averages and the difference between these averages is known as ‘divergence’.
Traders may buy the stock when the MACD line crosses above the signal line and sell when the MACD line crosses below the signal line. Some common MACD indicators which are widely used are ‘crossovers’, ‘divergences’ and rapid rises/falls.
The MACD should be used in a proper trending market. It doesn’t work in a rangebound market.
Limitations of MACD
Limitations of MACD are:
MACD is not always a true indicator and can give fake or vague signals as well. For instance, there can be a bullish signal line crossover but a steep drop in share price.
Similarly, there can be a negative crossover but a sharp rise in the stock price.