Moving Average Convergence Divergence[MACD]

Previously, we explained how exponential moving averages were just modified simple moving averages. Now we’re going to explain the Moving Average Convergence Divergence, often known as simply “the MACD.”

The MACD helps us see the convergence and divergence of a moving average—convergence is what happens when two moving averages converge, or come together, while divergence is what happens when they diverge, or move apart.

Here is a chart that shows the price of a currency pair, and also the moving average convergence divergence below the chart:

This chart is set up with a 12, 26, 9 setup, meaning that it uses three moving averages to compile the data. Do note that the 12, 26, 9 setup is the default setting on a trading platform. This setting can be modified, though it rarely, if ever, is modified from default.

How the MACD Works

The MACD works in a somewhat similar fashion to the exponential moving average—it places more emphasis on recent activity in the markets.

In the 12, 26, 9 setup, there is a 12, 26 and 9 period moving average. These work as follows:

• 12 and 26 – These two moving averages are the moving averages of the price for 12 periods and 26 periods.
• 9 – The third setting in the MACD, the 9, is a moving average based not on the price, but the difference between the 12 moving average and the 26 moving average. The MACD calculates the difference between the 12 SMA and the 26 SMA values, then averages it over the last 9 periods.

You see, the MACD measures convergence and divergence—how close and far apart the 12 and 26 moving averages are during the previous 9 periods. It’s like using a 12 and 26 moving average, but really only plotting 9 periods of each on the chart! Brilliance.

Using the MACD

Much like moving averages, the MACD identifies developing trends with crossovers. When the two lines in the MACD crossover, then we know that a new trend is emerging because the “faster” moving average is crossing with the “slower” moving average.

You can make sense of this with the chart below:

This is a pretty simple way to look at MACD. When the MACD crosses, a new trend is emerging, and traders should take a short or long position, based on the opposite of what was happening before. Thus, if the price were falling, and the MACD crossed, then the price is soon to rise. If the price was previously rising, and the MACD crosses, then the trader should take a short position.

Like all moving averages, there is a tendency for the MACD to “lag” changes in price. However, because the MACD is calculated on a 9-period moving average of the difference in the 12 and 26 moving average, it tends to show new trends faster than…say, the 12 and 26 moving averages.

See the difference here:

At any rate, the speed at which the moving average convergence divergence identifies new trades should not affect profitability. It can be used to confirm candlestick analysis, or maybe you’ll decide to confirm the MACD with other technical indicators that we’ll talk about in the next few lessons.