Moving average convergence/divergence (MACD) definition

What is the moving average convergence/divergence?

The moving average convergence/divergence (MACD) is a technical analysis indicator that aims to identify changes in a share price's momentum. The MACD collects data from different moving averages to help traders identify possible opportunities around support and resistance levels.

Convergence means that two moving averages are coming together, while divergence means that they’re moving away from each other.

The MACD indicator is made up of three components:

  • The MACD line, which measures the distance between two moving averages
  • The signal line, which identifies changes in price momentum and acts as a trigger for buy and sell signals
  • The histogram, which represents the difference between the MACD and the signal line

When calculating the MACD, only two lines are taken into consideration: the MACD line and the signal line. The MACD line is created by subtracting the 26-period moving average from the 12-period moving average. The signal line is the 9-period moving average of the MACD.

The MACD is then displayed as a histogram, a graphical representation of the distance between the two lines. If the MACD cuts through the signal line from below, traders could use it as a buy signal and if it cuts the signal line from above, traders might use it as a sell signal.

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Pros and cons of using the MACD

Pros of using the MACD

The MACD indicator is so widely used because it is both simple and reliable. Its popularity comes from the two different signals that it gives: the strength of the trend and the turning point of the trend. The MACD not only determines whether a trend is up or down, but it the strength of buy and sell signals.

Traders might choose to use a simple moving average strategy to set their buy and sell signals, but this gage can be delayed, which means the market conditions could change before the trade is executed. This is why the moving average convergence/divergence indicator is popular, as it provides an up-to-date representation of what is happening in the market.

Cons of using the MACD

As with any indicator, the MACD is not without flaws and should be used alongside other technical analysis tools.

One potential drawback is that the MACD is a short-term indicator, as the longest measurement that it takes into account is the 26-day moving average. If a trader has a longer-term outlook that this, the MACD may not be suitable.

Another potential downside is that the MACD is a trend following indicator. This means that the indicator gives its signals as the trend occurs, not before it starts. So, if you are looking to recognise an upcoming trend, the MACD is not the best indicator for this function.

Learn more about how the MACD works.

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