What is the MACD indicator and how to interpret it?

Presentation of the MACD :

MACD stands for Moving Average Convergence Divergence, an indicator of convergence and divergence of moving averages. It is an indicator created by an editor from the company Systems and Forcasts, Gerald Appel. It allows for a precise analysis of exponential moving averages.

To work, the MACD uses the difference between two exponential moving averages or EMAs based on the closing prices of an asset. It is the moving average of this difference that is of interest here.

It is essential to use only closing prices to apply this method of analysis, which was originally created to compare 26 and 12 day moving averages.

MACD representations :

Like most technical indicators, the MACD is represented visually, on a chart. There are two types of displays and therefore different representations of this indicator:

• The first is a curve representation which is most often used for medium and long term analysis.
• The second method is a histogram representation and is more particularly used for short-term analyses.

Some traders use both types of display simultaneously, but if you want to use this method, you will have to take into account the scales that differ from one method to the other.

Thanks to its graphical representation, the MACD is an excellent trend indicator. It has the advantage of being based on moving averages, making their interpretation even more accurate and reliable.

How is the MACD calculated?

To determine the MACD, you have to use the difference between two exponential moving averages. But this method of calculation is rather simple to understand. In this calculation, the last closing price will have more importance than the other prices of the same period, but it is the level of this importance that varies according to the exponential percentage used.

Each time there is a new closing price, the difference between the exponential moving averages of two different durations is calculated. The result is then used to calculate the last 8 closing prices in order to make a kind of 9-day exponential moving average on the differences between the exponential moving averages of the two time periods used.

How to use the MACD in trading :

The MACD is the indicator of choice for online trading. However, there are several ways to interpret it.

The first method is to look for crossings between the MACD curve and the signal line. When the MACD curve crosses below the signal line, this is an indication of a decline. Conversely, when the MACD crosses above the signal line, it is a bullish indication. When crosses occur in the so-called overbought or oversold areas, they are considered more reliable indicators than others.

The other interpretation technique uses the divergences between the evolution of prices and the MACD. More clearly, it is a question of identifying the moments during which the MACD curve evolves in opposition to the signal line.

MACD crossings and divergences and their interpretation :

As we have just seen in detail, the MACD can be a high quality technical indicator as long as the investor who uses it understands and interprets it consistently. There are currently two main methods of using this indicator effectively in trading, namely detecting crosses with the signal line and divergences between the price line and the MACD trend. Here is how to use these two chart elements.

• Interpretation of MACD crossings: To detect them, it is necessary to associate with the MACD line another line called the signal line, which comes from a shorter Exponential Moving Average. Thus, when the MACD line crosses this signal line upwards or downwards, we obtain a buy or sell signal. This method is often referred to by traders as the crossover or crossing method.
• As far as the interpretation of divergences is concerned, we use the divergences between the MACD and the real price of the asset. These divergences make it possible to identify a loss of momentum and thus to effectively anticipate an upcoming trend reversal or a radical change. Of course, the stronger the divergence, the more important the reversal signal will be.

What are the advantages and disadvantages of the MACD?

Of course, as is often the case with all the technical indicators you can use on your trading platform, the MACD has its advantages but also its disadvantages, which we suggest you discover here in more detail before putting this analysis into practice as part of your strategy.

Let's start of course by talking about the many advantages of this MACD indicator. The main advantage of this indicator compared to other trend indicators is that it is able to be extremely reactive. This means that the MACD can usually identify the most important trend changes very quickly.

Indeed, it is undoubtedly for its reactivity that the MACD is a very popular indicator in the world of trading since investors most often prefer it to indicators based on conventional moving averages. It is therefore the fact that the MACD uses an exponential average that allows for the accentuation of deviations and differences that makes this indicator advantageous in allowing one to spot an interesting movement very quickly and at a glance.

However, the MACD indicator also has some defects and limitations. Indeed, the early detection and forecasting of this indicator is not only an advantage but can also be considered as a flaw. We know that the earliest indications are often those that present the greatest risk of error. Therefore, although the MACD is an asset in terms of speed of analysis, this large margin of error is its main weakness and can present a significant risk for the investor. This is why we advise you to use the MACD only in conjunction with another technical indicator that will allow you to validate or invalidate the signals obtained.

Another shortcoming of the MACD is that, like all technical indicators, it does not take into account all of the stock market prices of an asset, but only a few of the recent prices that you are currently analyzing. The MACD will not therefore summarize the past prices of this asset. It is only on the basis of the correlation between the prices of the asset over the period studied that the MACD bases its predictions. However, this correlation is highly variable and can therefore also present certain risks.