Before going to study MACD, let's see moving averages in brief.
Moving average, as name suggests, is average of close prices of a particular stock over a predetermined period of time.
The addition of close prices of stock is taken & that is divided by number of periods.
Simple moving average - Every next value is calculated by deleting the earlier value & adding nearest close. The graph so formed is called simple moving average (SMA).
The time period to be selected for SMA depends upon the traders requirement,for which time period the trader wants to trade a particular stock.
Generally 20-day SMA & 50-day SMA are used for short term trading while 100-day SMA & 200-day SMA are used for long term trading.
Exponential moving average( EMA) -
EMA gives more importance to recent values,thus more sensitive to changes in price.
How to calculate EMA-
To start with,the SMA of predetermined period is taken as the first value of EMA.
SMA(n)=c(1)+c(2)+c(3)+......c(n) /n
Where SMA(n)=simple moving average over a predetermined period .
c(1),c(2),c(3)....=close prices over a period.
n=chosen period( days) .
As EMA gives more weightage to recent prices, weighting multiplier is to be calculated .It varies from period to period.
Weighting multiplier = 2 /1+time period
Then EMA is calculated by following formula-
EMA =multiplier *(close - previous day EMA) +previous day EMA.
Moving average can be used for swing trading by crossover methods.
First method -
In this method, the chart of moving average is plotted on the stock price chart & the crossovers are used as trend reversal signals(entry & exit).
When moving average chart crosses price chart & comes below, it is treated as buy signal.
When moving average chart crosses price chart & goes above it is treated as sell signal.
Second method -
For a stock price chart, two moving averages for two different periods (say 20-day & 50-day) are calculated & plotted on stock price chart .The crossover of two moving averages is treated as trend reversal .
When short term moving average crosses long term moving average & proceeds above, it is treated as buy signal.
When short term moving average crosses long term moving average & proceeds below, it is treated as sell signal.
Moving averages are trend following indicators & generally used for identifying the trend. These are useful in strong uptrend or downtrend sustaining over a longer duration.
Moving averages have no upper & lower boundaries, hence unable to show oversold & overbought conditions.
Keeping these things in mind theory of moving average converge divergence (MACD) is developed.
Moving average convergence divergence (MACD) -
This theory is developed by Gerald Apple.
MACD measures the divergence or convergence between short term moving average & long term moving average. It is calculated by subtracting longer period EMA from shorter period EMA. Generally 12 & 26-day EMA are used. The graph thus plotted is called fast MACD line.
MACD = 12day EMA - 26day EMA
A 9-day EMA of fast MACD line is then plotted on the top of MACD shown by dotted line. This is called slow signal line.
MACD uses two lagging indicators (EMA) & then it is converted into momentum oscillator by subtracting longer term moving average from shorter term moving average.
The resulting line, MACD, oscillates above & below zero, without any upper or lower boundaries.
If MACD is greater than zero, it indicates bullish signal (uptrend), as short term EMA is greater than long term EMA.
If MACD is less than zero, it indicates bearish signal (downtrend),as short term EMA is less than long term EMA.
The MACD histogram is calculated by taking the difference between fast MACD line & slow signal line.
MACD histogram = MACD line - signal line.
How to trade MACD-
1. When MACD crosses & proceeds above signal line, it is treated as buy signal.
2. When MACD crosses & falls below signal line it is treated as sell signal.
These signals should be confirmed with other indicators .
3. When MACD line proceeds above zero line from below ,it is treated as buy signal.
4. When MACD line drops below zero line from above ,it is treated as sell signal .
The above figure shows candlestick chart & below it MACD graph is plotted. The two curves indicate MACD line & slow signal line. Initially MACD line crosses & drops below signal line & then goes below zero line (horizontal line).when again MACD line crosses signal line & proceeds above zero line the strong uptrend is started.
Moving average, as name suggests, is average of close prices of a particular stock over a predetermined period of time.
The addition of close prices of stock is taken & that is divided by number of periods.
Simple moving average - Every next value is calculated by deleting the earlier value & adding nearest close. The graph so formed is called simple moving average (SMA).
The time period to be selected for SMA depends upon the traders requirement,for which time period the trader wants to trade a particular stock.
Generally 20-day SMA & 50-day SMA are used for short term trading while 100-day SMA & 200-day SMA are used for long term trading.
Exponential moving average( EMA) -
EMA gives more importance to recent values,thus more sensitive to changes in price.
How to calculate EMA-
To start with,the SMA of predetermined period is taken as the first value of EMA.
SMA(n)=c(1)+c(2)+c(3)+......c(n) /n
Where SMA(n)=simple moving average over a predetermined period .
c(1),c(2),c(3)....=close prices over a period.
n=chosen period( days) .
As EMA gives more weightage to recent prices, weighting multiplier is to be calculated .It varies from period to period.
Weighting multiplier = 2 /1+time period
Then EMA is calculated by following formula-
EMA =multiplier *(close - previous day EMA) +previous day EMA.
Moving average can be used for swing trading by crossover methods.
First method -
In this method, the chart of moving average is plotted on the stock price chart & the crossovers are used as trend reversal signals(entry & exit).
When moving average chart crosses price chart & comes below, it is treated as buy signal.
When moving average chart crosses price chart & goes above it is treated as sell signal.
Second method -
For a stock price chart, two moving averages for two different periods (say 20-day & 50-day) are calculated & plotted on stock price chart .The crossover of two moving averages is treated as trend reversal .
When short term moving average crosses long term moving average & proceeds above, it is treated as buy signal.
When short term moving average crosses long term moving average & proceeds below, it is treated as sell signal.
Moving averages are trend following indicators & generally used for identifying the trend. These are useful in strong uptrend or downtrend sustaining over a longer duration.
Moving averages have no upper & lower boundaries, hence unable to show oversold & overbought conditions.
Keeping these things in mind theory of moving average converge divergence (MACD) is developed.
Moving average convergence divergence (MACD) -
This theory is developed by Gerald Apple.
MACD measures the divergence or convergence between short term moving average & long term moving average. It is calculated by subtracting longer period EMA from shorter period EMA. Generally 12 & 26-day EMA are used. The graph thus plotted is called fast MACD line.
MACD = 12day EMA - 26day EMA
A 9-day EMA of fast MACD line is then plotted on the top of MACD shown by dotted line. This is called slow signal line.
MACD uses two lagging indicators (EMA) & then it is converted into momentum oscillator by subtracting longer term moving average from shorter term moving average.
The resulting line, MACD, oscillates above & below zero, without any upper or lower boundaries.
If MACD is greater than zero, it indicates bullish signal (uptrend), as short term EMA is greater than long term EMA.
If MACD is less than zero, it indicates bearish signal (downtrend),as short term EMA is less than long term EMA.
The MACD histogram is calculated by taking the difference between fast MACD line & slow signal line.
MACD histogram = MACD line - signal line.
How to trade MACD-
1. When MACD crosses & proceeds above signal line, it is treated as buy signal.
2. When MACD crosses & falls below signal line it is treated as sell signal.
These signals should be confirmed with other indicators .
3. When MACD line proceeds above zero line from below ,it is treated as buy signal.
4. When MACD line drops below zero line from above ,it is treated as sell signal .
MACD drawn below candlestick chart
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