A stock market is a complicated place where hundreds of companies try to raise funds by offering shares in return. As an investor, you have to do a lot of research before you invest your money. This includes reading various trading charts, financial statements of the company and checking its performance over some time. One such technical term you’ll come across during your share market trades is Moving Average Convergence Divergence, often abbreviated as MACD. Let’s find out what it is in detail in this article.
What is MACD?
Developed in the late 1970s by Gerald Appel, the Moving Average Convergence Divergence oscillator is regarded as one of the most effective and straightforward momentum indicators. MACD is a trading indicator that is used for the technical analysis of stock prices. The indicator enables analysts to reveal directional changes, strength, momentum as well as the duration of a trend in the price of a stock.
How MACD works, the role of EMA and its interpretation?
Having explained what is MACD in stocks, let’s understand how it works. MACD is fundamentally regarded as an oscillator that highlights the strength of a trend, as well as its reversal. It relies on moving averages as inputs to derive the oscillator value. The MACD indicator typically converts three of the moving averages into two. Analysts use the exponential moving average or EMAs to sensitise the oscillator to the latest price movements.
As such, the Moving Average Convergence Divergence is simply the difference between fast and slow exponential moving averages. An EMA is a kind of moving average, which places a higher amount of significance and weight on the most recent data points. The EMA is sometimes also referred to as the exponentially weighted moving average. The EWMA reacts a lot more significantly, to the latest price changes as compared to a slow-moving average, which equally weights all observations.
How to calculate MACD?
To calculate Moving Average Convergence Divergence, you need to subtract the long-term EMA from the short-term EMA. The following are the MACD calculation formulae and an explanation of the same.
1. MACD Line: (12-day EMA – 26-day EMA)
2. Signal Line: 9-day EMA of MACD Line
3. MACD Histogram: MACD Line – Signal Line
It typically takes 12 and 26 days of exponential moving averages to construct MACD lines. MACD is thus calculated as the difference between the two EMAs values, i.e. (26 periods – 12 periods). A nine-day EMA is known as the signal line, which is then placed on top of the MACD line. It functions as a trigger to purchase and sale signals. As a trader, you can purchase securities when the MACD crosses above the signal line and sell them when it crosses below the signal line. You can interpret the Moving Average Convergence Divergence in various ways, although the most common methods include crossovers, divergences as well as rapid rises or falls.
Now that you know what is MACD and how to use it, you can go ahead and do the calculations to understand how your preferred stocks are performing. The MACD indicator is indeed unique as it brings together the trend and momentum in a single indicator. As an investor, you can apply this unique blend of momentum and trends to your daily, weekly, and monthly charts. For more details on MACD, you can consult our team of experts at Angel One.