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The MACD, Moving Average Convergence Divergence, indicator is probably the most popular indicator in use today. It is also one of the most misunderstood, with it often being described amongst chartists as ‘An average of an average’. Before we begin to dissect the MACD indicator it is necessary to mathematically define the signal line, reference line and histogram.
Depending on which charting program you are using, the formulas for the Signal line and the Reference line may be reversed. The values in these formulas are the universal default settings.
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Signal Line = 12 Day EMA - 26 Day EMA
Reference Line = 9 Period EMA of the Signal Line
Histogram = Signal Line - Reference Line
The following chart of Telstra shows how the MACD is interpreted as a ‘Buy & Sell’ indicator.
The histogram component of the MACD indicator can also be employed as a momentum oscillator. The signal line of the MACD measures the distance between the 12 day EMA and the 26 day EMA by subtracting one from the other. The distance between these 2 averages will fluctuate in sympathy with any change in the direction of price activity. The signal line is in fact amplifying any changes in the direction of price activity as shown in the following chart.
The reference line is a 9-day EMA of the signal line and, as such, is designed to lag behind the signal line. This lagging effect generates crossovers whenever there is any change in the direction of price activity. The MACD Histogram which was developed by Dr Alexander Elder, author of Trading for a Living, takes the whole process a step further by amplifying the difference between the signal line and the reference line. In doing so, the Histogram is measuring the rate of change of the direction of price activity which is in fact momentum.
It can be employed as a momentum oscillator by dividing it by the 26 day EMA to normalize it over time. This is a necessary step because the MACD Histogram, unlike most other momentum oscillators, is directly linked to price and as such has an unwanted tendency to increase in magnitude with any overall increase in price. The MACD Histogram Momentum Oscillator provides a generally smoother and less responsive signal than its more conventional and better known cousins, the RSI and Stochastic oscillators.
The MetaStock formulae for the MACD Histogram Momentum Oscillator is:
((Mov(CLOSE,12,E)-Mov(CLOSE,26,E)) -Mov(Mov(CLOSE,12,E)
-Mov(CLOSE,26,E),9,E))/Mov(CLOSE,26,E)
Most charting programs will allow users to overlay indicators with support/resistance lines. These lines can be positioned over the MACD histogram momentum oscillator to create overbought and oversold zones. There are no set rules or values for creating these zones and they can be adjusted to suit the behavior of each individual share as shown in the following chart of Telstra. Note that the scale of the MACD oscillator is of no importance and its magnitude will vary dramatically from share to share.
The following chart compares the MACD oscillator to the RSI and stochastic oscillators.
Author: Alan Hull
ActVest Pty Ltd
ACN: 101 040 939
www.alanhull.com
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Alan Hull is an authorised representative of Gryphon Learning, holder of Australian Financial Services Licence No. 246606 and registered training organisation provider No. 21327. None of Gryphon Learning Pty Ltd, its Authorised Representatives, the "Gryphon System", "Gryphon MultiMedia", and "Gryphon Scanner" take into account the investment objectives, financial situation and particular needs of any particular person and before making an investment decision on the basis of the "Gryphon System", "Gryphon MultiMedia" and "Gryphon Scanner" or any of its authorised representatives, a prospective investor needs to consider with or without the assistance of a securities adviser, whether the advice is appropriate in the light of the particular investment needs, objectives and financial circumstances of the prospective investor |
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This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.
Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument. We do not and cannot offer investment advice. For further information please read our . |
