Moving Average Convergence Divergence (MACD) Definition: Day Trading Terminology
The moving average convergence divergence, better known as MACD, is a technical indicator that is used for measuring the strength of a trend by using two moving average prices. It is calculated by subtracting the 26-day exponential moving average (EMA), known as the slow length, from the the 12-day EMA, known as the fast length. The indicator then uses a 9-day EMA that is plotted as a signal indicator on the MACD.
Typically traders will wait for conditions to be either overbought or oversold and wait for the signal line to crossover the moving average convergence divergence line as signal that the trend could be reversing and its time to enter the trade. However, no technical indicator is perfect alone and should be used in conjunction with other indicators to solidify the price action.
MACD Trading Strategies
In the chart above you can see the moving average convergence divergence on the bottom of the chart with the MACD line being the orange line and the blue line being the 9-day EMA signal line. When the indicator reaches +/-500 then conditions are getting overdone and is due for a reversal soon. Traders will then wait for the blue line to cross the orange line at these extremes signaling order flow is changing and either the buyers or sellers are stepping in. This is known as a cross-over strategy and is one of the more popular ones to use with the MACD.
Another popular strategy that may take some getting use to in order to recognize it is a divergence strategy. This happens with prices don’t match what the MACD is doing. For example, in the above chart you will see that prices are moving up denoted by the blue trend line but looking down at the MACD you’ll see that it is trending down signifying that there is a divergence and prices are likely to reverse soon.
Warrior Trading Pro Tip
Just like any indicator it is best to use in conjunction with other indicators. The MACD is a great indicator and a very popular one, but it isn’t the holy grail of indicators and is best used as a guideline. I find the divergence strategy to be more reliable as trends can stay strong and overbought/oversold for long periods of time making it hard to time the reversals.