Working down the list of technical indicators it seemed high time that we got better acquainted with the MACD (Moving Average Convergence Divergence) indicator.

This technical indicator can multi-task, but don’t worry; there’ll be plenty of charts to make life easy for you.

Explanation
The MACD is another oscillating indicator, used by technical analysts to identify short-term changes in trend and momentum. It was developed by Gerald Appel, who was obviously scornful of J Wilder’s more simplistic RSI and Parobolic SAR indicators. If you’ve read my earlier piece on Moving Averages then think of this as the more advanced paper.

The MACD indicator is made up from three moving averages, but these are condensed into two lines; let me explain:

1. The first line represents the difference between two exponentially smoothed moving averages (EMA) of closing prices. The standard EMAs used are 12 and 26 periods. This line is the faster line and is actually called the MACD line. It is the blue line on the paddypowertrader charts.
2. The second (slower) line is an exponentially smoothed moving average of the MACD line. This is usually a 9-period EMA and is called the Signal line or trigger line. This is the red line on the charts.

The ‘buy’ or ’sell’ signal is given when the MACD line crosses the signal line; more on that below.

Where To Find The MACD
On the chart, click on the ’settings’ box in the bottom left-hand corner. This will bring up the menu where you’ll find MACD in the middle, just above the RSI. The three settings are standard default values relating to the exponential moving averages; the first two (12 and 26) are EMAs of the closing prices, and the third value (9) is the EMA of the MACD line. This third value creates the second line, called the signal line. All crystal?

Now I’m a simple guy (some might add ‘lazy’) so I always tick the ‘H’ as well. This puts the MACD into a histogram that I find a lot easier on the eye. See for yourself in the section further down the page:

Using MACD To Trade
There are several ways of using MACD to trade; some, like the overbought/sold and divergence signals, use the same principles as the RSI and serve as an early warning system. A couple of other methods can be used to trigger the trade.

(1) Overbought/Oversold Levels
The further the line strays from zero the more overbought/oversold it is. As with the RSI this isn’t a reversal signal, but an amber warning to think about taking profits.

(2) Divergence Patterns
Like the RSI this is when a price continues to rise, but the momentum is fading. For example, a bearish divergence occurs when the MACD lines are well above zero and start to weaken, despite the price continuing to rise. This is flashing a big amber warning sign that the trend isn’t sustainable.

A bullish divergence occurs when the MACD lines are well below zero and start to rise, even though the price is continuing to fall.

(3) Signal Line Crossovers
Here a trade is triggered when the MACD line crosses the slower moving signal line. When the MACD line crosses up through the signal line it triggers a buy signal; when it crosses below the signal line. Yep you’ve got it.

(4) Centreline Crossovers
This method takes the above crossover and adds a high-vis’ safety vest. The centreline is at zero when the fast moving 12-period exponential moving average (EMA) and the slower moving 26-period EMA are equal; the shorter and medium-term trends are in balance giving a zero MACD. When the MACD line crosses above the centreline this reflects demand as the faster 12-period EMA pulls away from the slower moving EMA. The rising line suggests a pick up in demand. Conversely, when the MACD line crosses below the centreline it reflects a falling price not yet detected in the longer 26-period EMA.

MACD Histogram
I like the histogram; it keeps things simple. The histogram consists of vertical bars that represent the difference between the the MACD line and the Signal line. The zero point is when both lines have the same value; a number above zero (green bar) is when the faster MACD line is pulling away from the slower Signal line (i.e. there’s a pick up in demand). A number below zero (red bar) happens when the faster MACD line is falling more rapidly, indicating that the sellers are in control.

The MACD histogram can be used to:

• Spot a change in the trend. The bars may be positive (green), but a pattern of lower bars indicate that the trend is losing its momentum. This is a warning to think about exiting a trade, not a reversal signal.
• Check for a reversal signal. This occurs when the histogram crosses the zero line, though this is often used in conjunction with another technical indicator.

Conclusion
Like most technical indicators there’s an awful lot of interpretation and learning involved. For example, I find the centreline crossover method so damn safe it misses out on a lot of the fun; in fact it seems to get to the party just before the police raid and ends up in a load of trouble.

On the other hand, the signal crossover will put you into a lot more trades; too many in fact, as it will suffer a lot of whipsaws in a volatile market. If I use MACD I combine the Histogram version with the price breaking either an Support & Resistance line or a Moving Average line.

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Price Oscillator
The final part of this bumper package is on the Price Oscillator. This indicator is based on the difference between two moving averages (sound familiar?) and can be expressed either in absolute or percentage terms.

The oscillator fluctuates around zero, just like the MACD, and the ‘absolute’ version mirrors the MACD if similar periods are used. The Percentage Price Oscillator is found by subtracting the longer moving average from the shorter moving average and then dividing the result by the longer moving average. Because the Percentage Price Oscillator is a relative number it allows for comparisons across different time periods and different markets.

You can find this one down near the bottom of the ’settings’ menu; don’t forget to tick the extra box if you want the values in percentage terms.

I’ll hold my hands up; I don’t use the Price Oscillator. It might be brilliant, but I use enough indicators already.

I hope that’s been useful and I’ll try and incorporate a few working examples in the daily Technical Analysis pieces.