Moving Average Convergence Divergence (MACD) shows the difference of two moving averages – EMA12 and EMA26, and a 9-day EMA of the difference is plotted against it to trigger buy or sell signal.
There are three parameters in MACD:
- MACD line – the difference between the 12 and 26 period EMA
- Signal line – the 9 day EMA of the MACD line
- Histogram – a visual representation of the difference between the MACD line and the signal line
MACD is best use in range-bound market to detect the momentum change and overbought/oversold conditions within a price range.
Applications of MACD:
1. Detect overbought/oversold levels
When the MACD line is far above from the centerline, the market is considered to be in overbought condition; while the MACD line is far below the centerline, the market is deemed to be in oversold condition.
When the MACD line crosses above the signal line, a buying signal is generated; while the MACD line crosses below the signal line, a selling signal is generated.
If the price is moving higher, but the MACD line is moving lower, it signals the weakening of the up-trend or a reversal. If the price is moving lower, but the MACD line is moving higher, it signals the weakening of the downtrend or a reversal.