MACD indicator is an uncomplicated but an effective momentum indicator. Simplistically by subtracting two trend following averages, MACD is transformed into a momentum oscillator and it fluctuates over and below the zero or the cross over centre line, signifying convergence or divergence. MACD is used in conjunction with Signal Line and MACD histogram, and is calculated as follows:
MACD line = (12 day EMA – 26 day EMA)
Signal Line = 9-day EMA of MACD Line
MACD Histogram = MACD line – Signal Line
MACD indicator is used to specify convergence and divergence of the two moving averages with convergence occurring when the two averages approach each other and divergence as they depart from each other. The shorter moving average, 12 day EMA, is more responsive than the 26 day EMA. The MACD line oscillates at the centre line, being in the positive zone when 12 day EMA is greater than the 26 day EMA and being in the negative when the 12 day EMA is lower than 26 day EMA. A positive divergence, 12 day EMA>26 day EMA, would mean that the upward momentum is increasing and a negative divergence, 12 day EMA<26 day EMA, denoting a downward momentum. The accompanying histogram shows the point at which the cross over occurs, with histogram facing up when MACD is bullish and down when MACD turns bearish. Also a narrowing histogram suggests a crossover may be near whereas a widening histogram suggesting that ongoing trend may further strengthen.
Centerline crossovers are commonplace in MACD. A bullish centerline crossover occurs when the MACD line moves over zero line into a positive range. This occurs when the 12 day EMA moves over the 26 day EMA and a bearish centerline crossover occurs when MACD goes into the negative zone and the 12 day EMA moves below the 26 day EMA. The MACD line will remain negative when there is a sustained downtrend and this may last for weeks if the strength is strong. Opposing positive movements may also last for a continued long period of time, under sustained strength of the movement.
Signal line crossover MACD occur frequently. A bullish crossover occurs when the MACD line goes over the signal line. Similarly a bearish crossover is signified when MACD line goes below signal line. At extremes signal line crossovers remain imminent. At a positive extreme the signal line normally starts trending over the MACD showing a faltering momentum. At the negative extreme the Signal line may remain below the MACD showing a faltering momentum in the negative direction.
Divergences also occur when the MACD line trend is suggestive of a trend not caught alone with the price movement of underlying security/currency. A bullish divergence occurs when the price forms a lower low but the MACD line forms a higher low and a bearish divergence occurs when the MACD line forms a lower low compared to the price movement. In a price downturn, when MACD is in the negative, a bullish reversal may signify a reducing negative momentum with a rally on the horizon. A bearish divergence on an increasing price trend, would occur when MACD is above the zero line, but the rate of increase of price is reducing, which is shown with a MACD maintaining a low compared to the price. At the extreme and a waning momentum would be foretelling of a possible decline in the price. A very interesting phenomena may occur when price keeps rising amid bearish signals. This would happen when MACD went to a wide high positive value, and even though it is on a decreasing trend, but by the virtue of attaining its initial high positive value, price may keep on increasing at an ever so low decreasing trend. But this may mean that the price action is moving slightly incoherently with MACD, due to its initial upswing.