The MACD explained simply
The MACD compares two moving averages and shows whether a price is picking up speed or losing momentum. Its signals are reliable, but always a little late.
MACD stands for Moving Average Convergence Divergence. Behind the clunky name is a simple idea: when a short term moving average pulls away from a long term one, the price is gaining momentum. When the two come closer, momentum is fading. The MACD is built into almost every charting tool.
What it's about
Below the price you see three things: the MACD line, a second, calmer line called the signal line, and bars that show the gap between the two. When the MACD line is above zero, the short average is higher than the long one, so the price has mostly been rising lately.
An example: a stock's MACD line has been rising for days and the bars are getting longer. That means the rise is speeding up. If the bars get shorter again while the price is still rising, the rise is losing strength.
How it's calculated
You take a fast average over 12 days and a slow one over 26 days. Both are exponential, so recent prices count more. The MACD line is simply the fast average minus the slow one.
With numbers: the 12 day average is €52.40, the 26 day average €51.10. The MACD line is then at 1.30. The signal line is a 9 day average of the MACD line, and the bars are the gap between the two.
What signals traders read from it
- Crossing the signal line: When the MACD line rises above the signal line, many read it as a hint of rising prices. When it falls below, as a hint of falling ones.
- Zero line: When the MACD line rises above zero, the short average is back above the long one. That confirms an uptrend more than it spots one early.
- Divergence: The price makes a new high, but the MACD line doesn't. That can mean the rise is running out of strength.
Where it misleads you
The MACD is made of averages, and averages lag behind the price. By the time a crossover shows up, part of the move is already over. In sideways phases the lines cross back and forth all the time, and if you trade every signal, you pay for lots of small losses and lots of fees.
The MACD also has no fixed limits like the RSI. A value of 2 can be a lot for one stock and little for another. So never compare MACD values between different stocks.
An example trade with made up numbers
Jonas has €10,000 in his account and risks at most 1.5% per trade, so €150. On an €80 stock, the MACD line crosses above the signal line. Jonas buys and sets his stop loss at €76. Because he risks €4 per share, he buys 37 shares for €2,960. He pays a €1 fee to buy and another to sell, and the spread costs him about 2 cents per share on each order.
If it works: The price rises to €88, then the MACD crosses back down and Jonas sells. He's €296 ahead. After €2 in fees and about €1.50 in spread, roughly €292.50 is left.
If it goes wrong: The signal was a false crossover in a sideways phase. The price falls and the stop fills at €75.90. That's a €151.70 loss, about €155.20 with costs.
After a few false crossovers in a row, the profit from one good trade is quickly gone. That's why many people only use the MACD together with a look at the bigger trend.
Gerald Appel developed the MACD in the late 1970s. The default values 12, 26 and 9 date from a time when markets traded six days a week. They've stuck around out of habit anyway.
Formally, the MACD line is EMA(12) − EMA(26), the signal line is the EMA(9) of the MACD line, and the histogram is the difference between them. Because the signal line is an average of an average, it lags twice. That makes signals calmer, but also later.
A variant is the PPO, which expresses the same calculation in percent. That lets you compare stocks with different price levels. As with all trend followers, its usefulness depends heavily on whether the market is trending. In sideways phases, fees and slippage quickly eat up the small gains.
Summary
- The MACD shows whether a price is gaining or losing momentum.
- Its signals come late because it's made of averages.
- In sideways phases it produces many false signals.
Did you get it?
What does it mean when the MACD line is above the signal line?
That short term momentum has picked up recently. It's no guarantee that prices keep rising.
Why do MACD signals often come late?
Because the MACD and signal lines are built from averages of past prices and trail the move.
Why shouldn't you compare MACD values between two stocks?
Because the MACD is measured in euros and depends on the price level. A value of 2 means something different for an expensive stock than for a cheap one.
Sources and further reading
- StockCharts ChartSchool, MACD. View source ↗
- ESMA, investor information on trading risks. View source ↗
Related
- Moving averagesLesson
- RSIIndicator
- Spotting trendsLesson