Moving average convergence/divergence or the MACD is one of the simplest and most effective momentum oscillators ever created. The MACD is a trend-following momentum indicator. The indicator was developed by Gerald Appel in the late 1970s.
How does MACD work?
This indicator is well suited to identify entry and exit points. The MACD provides corresponding signals in the beginning and in the end of the trend.
Fast and slow lines
It may seem like understanding the principles behind the MACD is harder than putting the indicator into practice. To better illustrate the logic of the moving average convergence/divergence we can resort to the exponential moving averages (EMA) with periods of 12 and 26.
The following observations can be made by looking at the picture above:
- The intersection of two moving average lines on the price chart corresponds to the intersection of the fast MACD line (blue) and the horizontal zero line. The value of the MACD is equal to the difference between exponential moving averages with corresponding periods.
- The slow (orange) line in the MACD indicator window is the average of the MACD line (blue).
Green and red bars
The one can also note that alongside with blue and orange lines the MACD uses green and red bars.
Green bars will appear in the MACD window when:
- the fast line is above the slow line and the distance between the two lines is increasing;
- the fast line is below the slow line and the distance between the two lines is decreasing.
Red bars will appear in the MACD window when:
- the fast line is below the slow line and the distance between the two lines is increasing;
- the fast line is above the slow line and the distance between the two lines is decreasing.
It may seem a little bit complicated but the general idea behind the bars is simple. When the blue line moves up faster or moves down slower than the orange line, the MACD will display green bars. In the opposite case, the bars will become red.
MACD Settings for Day Trading
In order to use the MACD indicator in day trading, click on the “Indicators” button in the bottom left corner of the screen. Then choose the MACD from the list of possible indicators.
Click “Apply” if you want to use the indicator with standard parameters. Or you can adjust fast, slow and signal periods in the open tab.
The sensitivity of the indicator can be increased by decreasing the fast period and increasing the slow one.
How to Use Indicator in Day Trading?
Thanks to the complex nature of the indicator there are several ways to put the MACD into action.
Signal line crossovers. An uptrend is expected when the fast line turns up and crosses above the slow line. A downtrend is expected when the fast line turns up and crosses below the slow line.
Centerline crossovers. An uptrend is expected when the fast line moves above the zero line to turn positive. A downtrend is expected when the fast line moves below the zero line to turn negative.
Divergences. Divergences appear when the price chart and the MACD chart show oppositely directed movement. A bullish divergence forms when a security records a lower low and the MACD forms a higher low. A bearish divergence forms when a security records a higher high and the MACD Line forms a lower high. Divergence can be a sign of an upcoming trend reversal.
The MACD gives traders an opportunity to simultaneously use a trend-following and a momentum indicator. It can be applied to both short and long time intervals, making it an ultimate tool in the hands of a professional.