The MACD oscillator developed by Gerald Appel uses two exponential moving averages of closing prices. These are turned into a momentum oscillator by subtracting the longer moving average from the shorter moving average. This is the faster line you see on the chart.
The slower line, called the signal line is a 9 period exponentially smoothed average of the MACD line. Most traders use the 12, 26 and 9 default settings.
By comparing moving averages, MACD illustrates trend following characteristics, and by tracking the difference of the moving averages as an oscillator, MACD displays momentum characteristics.
Interpretation of the MACD Indicator
– A buy signal is generated when the MACD line crosses above the signal line.
– A sell signal is created when MACD crosses below the signal line.
MACD also moves above and below a zero line – as MACD extends far above the zero line it enter overbought territory, and the inverse.
The zero line can generate buy and sell signals as with the other indicators.
Look for divergence with price in extreme areas as a signal of possible price reversal.
The two MACD lines can be turned into a histogram by plotting the difference between the two MACD lines. The histogram crossing the zero line coincides with the MACD crossover buy and sell signals.
The histogram indicates the strength of the trend – if the histogram lines are getting closer to the zero line, this indicates that the trend is weakening – useful to guage exits from existing positions.