Wednesday, January 25, 2012

MACD Technical Analysis

MACD technical analysis

MACD technical analysis stands for moving average convergence/divergence analysis of stocks. This type of analysis tool was originally developed by Gerald Appel in the 1960’s. As the names of this analysis suggests, this analysis is based on the moving averages. This is a form of technical analysis and used by investors to know whether to hold the stock, buy more or sell it.
MACD technical analysis uses moving averages, creating a momentum oscillator by subtracting the longer term moving average from the shorter term moving average. In the end you get a line that crosses above and below zero without any limitations on the up or downside.


If you follow the graph above, you will notice after the point of crossover, as the trend increases in strength (i.e. the price rises or falls faster and for a longer time), the two MA lines diverge away from each other. As the trend decreases in strength, the two MA lines converge toward each other. The difference between the two EMAs is the convergence / divergence factor in a MACD indicator.

MACD = Short Term EMA – Long Term EMA

The MACD subtracts the long term EMA value from the short term EMA value and plots it onto an indicator chart. This results in either a positive value (if the trend is up) or anegative value (if the trend is down). The value that is plotted is an indication of how strong the trend is, meaning how large the divergence is. While the common default settings for the EMAs are 12 and 26 days, you can change those values to suit your
trading method to find what works the best for you.

Purpose of MACD

If the MACD is positive (i.e. the short term EMA is above the long term EMA), this indicates increasing upward momentum. Depending on your trading method, you may want to refrain from going short or if you were in a short position, this may be the indication to close out your position.

If the MACD is negative (i.e. the short term EMA is below the long term EMA), this indicates increasing downward momentum. Depending on your trading method, you may want to refrain from going long, or if you are in a long position, this may be the indication to close out your position.

Usually the MACD incorporates a 26 day and 12 day exponential moving average(EMA). 26/12 is the most common combination used by the experts where 26 day EMA is slower and 12 day EMA is faster.

Calculation of MACD
The MACD value can be calculated by simply deducting the longer EMA from the shorter EMA. This value oscillates around a zero point, zeros being where the 26 day EMA is identical, and therefore (usually) crosses over the 12 day EMA.

MACD = EMA (12) – EMA (26)

Characteristics of MACD

The MACD is:

MACD is a lagging trend deviation indicator using two EMAs as method of deviation.
        It is best when used as a technical indicator for long-term trends.
  It is plotted with stock trading software as a smooth series, ignoring insignificant price variation.
 Subject to whipsaw, often leading to poor market timing.

MACD interpretation:

Analysts who follow MACD technical analysis use the following guidelines:

When the MACD crosses over from below the signal line and rises above the signal, this is a sign to buy. Conversely, when the MACD crosses over from above and drops below the signal, this is a sign to get rid of the stock.
  • If the MACD crosses the zero point and moves from below zero to above zero, this is a buy signal and vice versa.
  • In sideways trending markets, there may be numerous cross-over, thus making interpretation unreliable. MACD buying signs are best used in a generally up trending stock or market.The signs to buy or sell are stronger if the movement up or down is sharp.