The moving average convergence divergence (MACD) indicator is a momentum indicator that is made up of three signals and is most often calculated by the closing price but can include any historical price data. As it is based on moving averages, it is very popular for technical traders who use it as a confirming indicator for online options trading. This is due to the volatility involved in trading options and the MACD being a stable indicator that prevents traders from getting in and out to early.
The three signal lines are the MACD line, the average line and the divergence. Often novice traders will mix up the MACD indicator with the specific MACD line, which can cause initial confusion and frustration. The MACD line is the difference of a fast EMA (exponential moving average) and a slow EMA. A signal line or ‘average line’ is where the MACD line is charted over a period of time with an EMA of the MACD. Any divergence between the signal line and the MACD line would typically be shown as a histogram or bar graph. The MACD line can show trend changes in a stock if comparing different periods of EMA’s. This can allow a trader or analyst to pick up any small shifts in the stock’s trend.
Often referred to as a lagging indicator, the MACD should not be used with stocks that are trading erratically or are not trading within range when price trends is a metric being utilized. Despite its lagging nature, the MACD does not lag quite as much as a basic moving average crossing indicator.
By subtracting the 26 day exponential moving average (EMA) from the 12 day EMA results in the MACD. From here, a 9 day EMA of the MACD or ‘signal line’ can now be plotted which can then be used as a trigger for buying and selling signals.