Introduction
A lot of research is required to navigate the opportunistic yet complicated world of the stock market. You will come across various technical terms during your research. One such variable is the MACD. The full form of MACD is Moving Average Convergence Divergence. It is a widely used momentum indicator. It assists you in identifying trends and potential buying or selling opportunities in the stock market. Developed by Gerald Appel in the 1970s, MACD is a formidable factor that helps understand trends and reversals. It does so by identifying the difference between two moving averages. You can recognise the MACD indicator as two lines on the chart that oscillate without boundaries.
How to use the MACD indicator?
The MACD indicator reveals changes in the strength, direction, momentum, and duration of a trend in a stock's price. It is an effective indicator in recognising potential entry and exit points. The relationship between two moving averages or period intervals. These two moving averages are based on historical closing prices. You can use the MACD indicator by learning how to read it:
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Understand the Two Lines
There are two lines in the MACD indicator – MACD and the Signal line, respectively.
- MACD Line: The line shows the difference between two moving averages of a stock's price, in 12-day and 26-day periods.
- Signal Line: You will find this 9-day line in red on the chart. When the signal line crosses the MACD line, it acts as a trigger to buy or sell. This line is known to smooth out fluctuations.
- Look for Crossovers: A crossover occurs between the two lines discussed above. When the MACD Line crosses over the signal line, it indicates a bullish market (buying opportunity).
In the opposite case, that is when the MACD line crosses below the signal line, it indicates a bearish market (selling opportunity).
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Watch for the Zero Line Crossover
Besides the crossovers understood in the previous point, there are instances when the crossovers happen above or below zero. If the MACD line moves above zero, it suggests the stock is gaining strength. Instead, if it moves below zero, it indicates weakness.
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Check the Histogram
A histogram refers to a bar chart that shows the difference between the MACD and the signal line. If it has tall bars, you can suspect a strong momentum. Shrinking bars, on the other hand, indicate a possible reversal.
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Use in Trending Markets
Once you have a proper understanding of all the possible ways in which the MACD linex works, you can form trading strategies around it. The MACD typically works best in markets where stocks are moving in a clear uptrend or down. In sideways markets, the MACD signals alone might not be enough.
How MACD works
The MACD operates within the 12-day and 26-day Exponential Moving Average (EMA). It is designed to track momentum shifts by measuring the interaction between these two moving averages. It reveals trend strength and potential reversals in a single glance. The MACD reacts quicker than simple moving averages to market movements. It lets you identify the early signals of a trend shift rather than waiting for a price action to confirm it.
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Calculation of Moving Average Convergence Divergence
The MACD formula for calculation is:
MACD = 12-day EMA – 26-day EMA
Here,
12-day EMA is the Exponential Moving Average of the stock's closing price over 12 days.
26-day EMA is the Exponential Moving Average of the stock's closing price over 26 days.
The result of the subtraction of 12-day EMA by 26-day EMA is the MACD line. As discussed earlier, the 9-day EMA between this range is known as the signal line. It helps identify the potential buy and sell signals.
Interpretations of MACD in the stock market
You can interpret the MACD line in various ways to make informed trading decisions.
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As noted earlier, a crossover of the MACD line above or below the signal line indicates a bullish or bearish market.
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If the MACD diverges from the stock's price, it may indicate a potential trend reversal, which is also known as weakening momentum.
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When the MACD line moves significantly above or below the zero line, a stock is overbought or oversold. As a result, there is a potential reversal.
Conclusion
The MACD indicator is a widely used indicator for technical analysis. It provides you with valuable insights to understand a stock's momentum and trend direction. When you learn and effectively utilise the MACD, you can enhance your trading strategies. MACD allows you to make informed decisions in the stock market. Hence, it is a crucial addition to your technical analysis for successful trades.
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