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Technical Analysis, Education

The MACD Indicator (for beginners)

The MACD (Moving Average Convergence / Divergence) is an indicator used in technical analysis to give estimate and predict fluctuations of the asset prices. The indicator was first described by Gerald Appel in his book “Systems and Forecasts” in 1979. Thomas Esprey added a histogram to the MACD in 1986.

Signals and entry points


Being both a trend following indicator and an oscillator, MACD gives the types of signals to entry the market, which are logically quite different. The basic signals of the MACD indicator:

• Crossing the signal line

• Crossing the zero line

• Divergence

 

The signal line crossover


It is the most common and frequently used signal. The signal appears when the MACD line crosses the signal line. Of course, the type of signal depends on the manner of the intersection:

• The MACD line crosses the signal line in the upwards direction: it is a bullish signal.

• The MACD line crosses the signal line in the downwards direction: it is a bearish signal.

The MACD histogram will display a zero value, as it shows the difference between the MACD line and the signal line of the indicator.

 

The zero line crossover


There are two types of signals that we receive from the MACD line at the moment when it crosses the zero line of the indicator:

• The MACD line crosses the zero line in the upwards direction: it is a bullish signal.

• The MACD line crosses the zero line in the downwards direction: it is a bearish signal.

 

Divergence


Divergence is the disparity between the direction of the indicator and the price chart. A bearish divergence is formed when an asset records a higher high, and the MACD line forms a lower high. Conversely, a bullish divergence is formed when a lower low is not supported by a lower low on the MACD. Such signals are typical for all oscillators, including the MACD. As a rule, the occurence of a divergence indicates the completion of the movement (the weakening of the the trend) and a possible strong correction or a reversal. And, as for most other signals, there is a working rule that one should remember: the larger the timeframe of the price chart, the stronger the signal.

Recommendations


It is not necessary to have two local maxima / minima to form a divergence. There may be three or more. This means that the precise point of reversal can not be determined this way. The trend does not necessarily reverses. It can simply get flat. Thus, a divergence or a convergence only indicates the slowing of the trend’s strength. A divergence or a convergence can confirm some technical analysis patterns, like a double top or head and shoulders.

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