What is the Exponential Smoothed Differential Moving Average (MACD)?
Key takeaways
The Exponential Moving Average Convergence Divergence (MACD) is a simple yet effective momentum indicator that shows the relationship between two moving average lines.
The crossover relationship between the DIF line and DEA line can to some extent reflect trading signals.
The MACD indicator can be applied to analyze crossover and divergence signals.
Understand MACD
The Moving Average Convergence Divergence (MACD), proposed by Gerald Appel in 1979, is a trend-following momentum indicator. MACD usually consists of three components. The MACD line is the fast exponential moving average (generally 12 days) minus the slow exponential moving average (generally 26 days), commonly referred to as the Difference (DIF). The second line is the signal line, which is the exponential moving average of the DIF (generally 9 days), commonly referred to as DEA. The last component is the MACD histogram, whose value is the difference between DIF and DEA. However, the time parameters of the MACD indicator can also be adjusted according to the trader's preferences and trading category.
The inherent logic of the DIF is that the short-term exponential moving average reflects the current price trend, while the long-term EMA reflects an earlier price trend. Therefore, if there is a significant difference between these two EMAs, the market has an upward or downward trend. The MACD histogram oscillating near the zero line indicates the strength of the trend.
How to apply MACD
Cross identification
The crossover between the DIF line and the DEA line can indicate the trend of price changes.
In MACD analysis, when the DIF line crosses above the DEA line, this may be a call signal.
When the DIF line crosses below the DEA line, this may be a put signal.
Divergence
When the DIF line and price changes have opposite trends, a divergence signal occurs. Divergence signals in MACD analysis indicate that the trend may reverse.
For example, when the DIF line has an upward trend but lower prices occur, a bullish divergence signal appears, indicating that prices may rise.
Conversely, when the DIF line has a downward trend but higher prices occur, a bearish divergence signal is generated, indicating that prices may fall.
Limitations of MACD
MACD indicator is very simple and practical, but it still has some drawbacks. Because the moving average line measures the changes in a stock's price over a period of time, for large short-term price changes, MACD will not immediately generate a signal and will have some lagging.
Therefore, when using the MACD indicator for signal determination and trading decisions, one should also consider the situation of other indicators and make a comprehensive judgment.
