Developed by Gerald Appel in 1979, MACD utilizes two Exponential Moving Averages (EMAs) and a signal line, which helps traders make more informed buy and sell decisions.
To calculate MACD, the 12-day and 26-day EMA are determined first, and then subtracted from each other. This difference results in the MACD line, which is displayed as a line graph. Traders use the ‘centerline’ approach to read this MACD line, plotting a horizontal line at point zero to distinguish between positive and negative areas. If the MACD line crosses below the centerline, it signifies divergence between the two EMAs, signaling that the stock has rising momentum and an opportunity for buyers. In contrast, if the MACD line crosses the centerline from above, it indicates the EMAs are converging and traders should consider selling the stock.
Besides the centerline approach, traders also developed the ‘signal line’ – the 9-day EMA of the MACD line. This assists traders in making buy and sell decisions as it alerts them when the MACD line crosses the signal line from below or above. The MACD value will either be positively or negatively charged depending on the relative positions of the two EMAs.
Knowing how to interpret the MACD indicator is essential for traders to understand the current market direction and make informed trading decisions. However, standard MACD settings of 12-day, 26-day, and 9-day EMA may not be the optimal for traders that day trade, swing trade, or scalp. For swing trading, traders often use 0 as the baseline, while for scalping tactics, traders often utilize 50-day EMA and 100-day EMA settings. As for traders who prefer to use 5-minute charts, they may choose to use the default 12, 26, 9 settings or alternatively, 24, 52, and 18.
In addition to this, traders can also refer to the MACD histogram to anticipate changes in price and potential trend reversals. When the blue MACD line crosses the orange signal line, a histogram appears above or below the baseline depending on the direction of the crossover. Furthermore, traders may also use the MACD signal to generate profits through trading MACD crossovers and trading MACD divergence.
That said, it is important to note that MACD may fail to accurately forecast all reversals, so traders should always use other indicators like 9-day and 14-day Simple Moving Averages (SMAs) to validate signals before buying or selling a stock.