Understanding and knowing how to trade MACD is important for success in trading. It gives reliable buy and sell signals.
Reading MACD or Moving Average Convergence Divergence is an important part of technical analysis. MACD is a technical Oscillator. In fact, MACD is a dual indicator. This is because it has characteristics of an oscillator as well as a moving average.
MACD was developed by Gerald Appel. It is considered as a more reliable and important technical indicator.
It is important that as a trader you know how to read MACD.
When plotted on a graph, we see that MACD is made up of two lines :
1. MACD Line
2. Signal Line
MACD Line, also known as Faster Line, is made up of difference of Exponential Moving Averages for closing prices of two time periods. These two time periods are usually 12 and 26. It can be 12 and 26 days or 12 and 26 weeks, depending upon how you want to use it.
Signal Line, also known as Slower Line, involves Exponential Moving Average of closing prices of the security. It can be for a period of 9 days or 9 weeks. Most commonly used set of numbers to draw MACD is 9, 12 and 26. However, you can adjust these numbers according to your trading preferences.
As with other technical indicators and Moving Averages, we need not to calculate them and draw those graphs. The charting software do it by themselves.
Moving Average Convergence Divergence or MACD lines keep oscillating above or below the zero line. This is a character of a technical oscillator and that is why MACD is an Oscillator.
How To Read MACD or Moving Average Convergence Divergence
We look for crossovers of MACD and Signal Line while reading MACD for trading signals. These crossovers may occur above the zero line or below the zero line. Crossovers above or below the zero line has their own significance.
Buy Signal – A buy signal is generated when the MACD Line crosses above the Signal Line. A crossover happening far below the zero line is more significant and can be the best buy signal.
The reason is that the area below the zero line corresponds to oversold zone. The more away we are from the zero line the more is the oversold situation. The area above the zero line corresponds to overbought zone. The farther we are from the zero line more is the overbought situation.
Some traders may use zero line crossovers as the buy signals and some even trade the crossovers happening above the zero line.
Sell Signal – A sell signal is generated when the MACD Line crosses below the Signal Line. As we talked above, the more appropriate or reliable Sell Signal may be generated when the crossovers happen far above the zero line which is the highly overbought region.
Divergences – Divergences happen when the MACD indicators move opposite to the security prices. A Bullish Divergence is one in which the security prices are moving lower while the MACD is moving higher. This indicates that the bottom for security prices is in place and prices are likely to move higher in near future.
Bearish Divergence MACD is when the security prices are moving higher while the MACD indicator has started moving lower. This indicates the prices are topping out and may move lower in future.
It is always better to use other technical indicators in conjunction with one indicator to compliment the interpretations. This also helps the traders to avoid the false trading signals.