MACD

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MACD 12,26, 9

MACD, which stands for Moving Average Convergence / Divergence, is a technical analysis indicator created by Gerald Appel in the 1960s. It shows the difference between a fast and slow exponential moving average (EMA) of closing prices. During the 1980s MACD proved to be a valuable tool for any trader. The standard periods recommended back in the 1960s by Gerald Appel are 12 and 26 days:

MACD = EMA[12]\,of\,price - EMA[26]\,of\,price

A signal line (or trigger line) is then formed by smoothing this with a further SMA. The standard period for this is 9 days,

signal = SMA[9]\,of\,MACD

The difference between the MACD and the signal line is often calculated and shown not as a line, but a solid block histogram style. This construction was made by Thomas Aspray in 1986. The calculation is simply

histogram = MACD − signal

The example graph above right shows all three of these together. The upper graph is the prices. The lower graph has the MACD line in blue and the signal line in red. The solid white histogram style is the difference between them.

The set of periods for the averages, often written as say 12,26,9, can be varied. Appel and others have experimented with various combinations.

Contents

[edit] Interpretation

MACD is a trend following indicator, and is designed to identify trend changes. It's generally not recommended for use in ranging market conditions. Three types of trading signals are generated:

  • MACD line crossing the signal line.
  • MACD line crossing 0.
  • Divergence between price and histogram, or between MACD line and price.

The signal line crossing is the usual trading rule. The standard interpretation is to buy when the MACD crosses up through the signal line, or sell when it crosses down through the signal line. These crossings may occur too frequently, and other tests may have to be applied.

The histogram shows when a crossing occurs. When the MACD line crosses through zero on the histogram it is said that the MACD line has crossed the signal line. The histogram can also help visualizing when the two lines are coming together. Both may still be rising, but coming together, so a falling histogram suggests a crossover may be approaching.

A crossing of the MACD line up through zero is interpreted as bullish, or down through zero as bearish. These crossings are of course simply the original EMA(12) line crossing up or down through the slower EMA(26) line.

Positive divergence between MACD and price arises when price makes a new selloff low, but the MACD doesn't make a new low (i.e. it remains above where it fell to on that previous price low). This is interpreted as bullish, suggesting the downtrend may be nearly over. Negative divergence is the same thing when rising (i.e. price makes a new rally high, but MACD doesn't rise as high as before), this is interpreted as bearish.

Divergence may be similarly interpreted on the price versus the histogram, where the new price levels are not confirmed by new histogram levels. Longer and sharper divergences (distinct peaks or troughs) are regarded as more significant than small shallow patterns in this case.

It is recommended to look at a MACD on a weekly scale before looking at a daily scale to avoid making short term trades against the direction of the intermediate trend.[1]

Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day.

[edit] Creator

Gerald Appel developed the Moving Average Convergence-Divergence (MACD) Indicator, and has written twelve books relating to investment strategies, including Winning Market Systems, Double Your Money Every Three Years, Stock Market Trading Systems, The Big Move, New Directions in Technical Analysis (co-author, Dr. Martin E. Zweig), and Time-Trend III. In addition, Gerald has had many articles published in such publications as Money, Barron's, and Stocks and Commodities magazines. He has also produced and appeared in a number of videotapes related to technical investment strategies. Gerald has presented at a number of seminars within the United States and abroad, and has appeared on "Wall Street Week" with Louis Rukeyser and is a frequent guest on other television programs on the financial news networks and elsewhere.[2]

Mr Appel published frequently in the 1970s & 1980s, in a time when computerized tools became available to professional investors but were much less accessible to retail investors. As computerized technical analysis relies on back-testing, it is not surprising that strategies announced year-by-year by Mr. Appel became vulnerable, year-by-year, to failure, as "past results do not guarantee future success". Nevertheless, the author's research has been respectable & innovative.

[edit] Signal Processing

The MACD is a filtered measure of the velocity. The velocity has been passed through two first order linear low pass filters. The "signal line" is that resulting velocity, filtered again. The difference between those two, the histogram, is a measure of the acceleration, with all three filters applied. The "MACD crossing the signal line" suggests that the direction of the acceleration is changing. "MACD line crossing zero" suggests that the average velocity is changing direction.

[edit] Criticism

With the emergence of computerized analysis, it has become highly unreliable in the modern era, and standard MACD based trade execution now produces a greater distribution of losing trades[citation needed]. Some additions have been made to MACD over the years but even with the addition of the MACD histogram, it remains a lagging indicator. It has often been criticized for failing to respond in mild/volatile market conditions.[3] Since the crash of the market in 2000, most strategies no longer recommend using MACD as the primary method of analysis, but instead believe it should be used as a monitoring tool only. It is prone to whipsaw, and if a trader is not careful it is possible that they might suffer substantial loss, especially if they are leveraged or trading options.

[edit] References

  1. ^ Murphy, John (1999). Technical Analysis of the Financial Markets. Prentice Hall Press. pp. 252–255. ISBN 0735200661. 
  2. ^ Gerald Appel Biography - INO TV
  3. ^ Fidelity Trend Trading with Short-Term Patterns Retrieved on May 12, 2007

[edit] See also

[edit] External links

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