Introduction
MACD was created in an attempt to determine the strength of a trend
along with the direction of that trend. Gerald Appel created a system
that looked at two exponential moving averages and the difference
between those two averages. Looking at these moving averages of the
market we are able to see clear buy and sell signals. We are also able
to get a more accurate signal by looking at an average of the difference
in the two moving averages.
Interpretation
Computing this indicator requires the use of exponential moving
averages. Exponential moving averages are different than simple moving
averages because instead of looking at only the last few days and
averaging them, the exponential averages look at all the prices, and
then put more weight on the most recent data. This type of weighted
average gives a smoother average price that reacts more quickly to
market moves. The two averages of MACD move above and below a base line,
which gives indication of the strength of the current move. This
placement of the two averages in relationship to the base line is
calculated by looking at the exponential moving average of the
difference between the two averages. So, even though the two averages
may cross, the divergence, or true indication of the signal, is not
shown until both averages cross the base line.
Keeping this in mind, an ideal buy signal is seen on a move where the
shorter-term average moves above the other average and both averages
cross above the base line of zero. Inversely, a sell signal would be the
opposite of this.
The histogram method of MACD is read as a straight line above or below
the zero base line. This line represents the difference between the
Moving Averages. Therefore, when the moving averages move above the base
line they are indicating a buy, and as the difference between the
averages increases the lines will get taller.
The opposite is true of a sell signal. Track 'n Trade Pro's ability to
display MACD in this fashion is vital because it allows you to read the
strength of the current trend along with the signal to buy or sell.
When MACD is plotted as a histogram, the values used to plot the
histogram are the differences between the two moving averages on each
day. The "trigger" line that appears on this chart is an average of the
histogram data, or a smoothed view of the histogram.
Using the MACD as a histogram will allow the trader to spot divergences
between the indicator and the market price. A divergence is present when
the market makes a higher high than the previous high, but the MACD
histogram fails to make a corresponding higher high. This is considered
- in technical lore - to be a sign of weakness and a sell signal when
the MACD breaks below the lowest point in between the divergent highs.
Bullish divergence is seen in an exact opposite fashion. Assume a market
has been trending downward. The market has been consistently making
lower lows, as has been the MACD histogram indicator. However,
eventually the MACD fails to make a lower low, corresponding to the
lower low in price. If the MACD histogram line crosses above the highest
high in between the divergent lows, then technical lore holds that
higher prices should follow.
Example of the MACD in the indicator Window:
You also have the
choice to view the MACD indicator in a simple line style, instead of the
histogram. In this view there is no trigger line. The line style MACD
gives buy and sell signals based off of the crossing of the two moving
averages.
Example of the Line Style MACD in the Indicator Window:
Calculation
Parameters:
 |
First (12) - the number of bars, or
interval, used to calculate the first Exponential Moving Average. |
|
|
Second (26) - the number of bars, or
interval, used to calculate the second Exponential Moving Average.
|
|
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Difference (9) - the number of bars,
or interval, used to calculate an additional Exponential Moving
Average. |
Formula:
In this study, the oscillator is the simple difference between the first
two exponential moving averages. The formula is as follows:
OSCt = (EMA1 - EMA2)
OSCt: The oscillator for the current period.
EMA1: The first exponential moving average.
EMA2: The second exponential moving average.
The second part of the study computes an exponential moving average of
the oscillator. You have:
EMAosct = EMAosct-1+ (k * (OSCt - EMAosct-1))
EMAosct: The exponential moving average of the oscillator.
OSCt: The oscillator for the current interval.
EMAosct-1: The exponential moving average of the oscillator for
the previous interval.
k: The exponential smoothing constant.
Since the second value, EMAosct, is an exponential moving average, it
rises and falls more slowly than the oscillator. Hence, the two lines
generate crossover points. These crossover points are the buy/sell
signals. Review Reading Moving average Convergence/Divergence Trading
Signals for other possible trading signals.
If the study is displayed as a histogram, each value for the lines is
calculated as:
DIFFt = OSCt - EMAosct
DIFFt: The difference between the oscillator for the current
interval and the exponential moving average of the oscillator.
OSCt: The oscillator for the current interval.
EMAosct: The exponential moving average of the oscillator.
Customizing
To change the settings of this indicator, open the Program Options
screen by clicking the "Program Options" button located on the main
Toolbar.
See the Program Options section for more details on changing the
settings.
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