Technical Indicators like the MACD are extremely valuable to stock market technicians looking to gain any type of advantage when it comes to identifying high probability buy and sell signals.

Discover the power that the MACD Indicator can give you by understanding exactly what this oscillator is, how it is calculated, and how you can apply it to any stock chart over any time frame for more accurate charting and trading results.

What is MACD?

The Moving Average Convergence Divergence (MACD) Indicator was developed by Gerald Appel (in the 1970′s) to indicate the strength of an any underlying trend and the likelihood of trend reversals.

To calculate this, Appel setup the MACD Formula so that it compares the difference between two exponential moving averages (EMA’s) based on closing prices. The use of exponential moving averages instead of simple moving averages means that this indicator puts more emphasize on recent prices and less emphasis on prices as you move further away from the most recent close.

Of the two moving averages used, the first is a short term moving average (usually 8 periods) and the second is a longer moving average (usually 17 periods).

Both of these averages are calculated on a daily basis but neither of them show up on the MACD Indicator.

2 Line MACD With Histogram

What does show up on this technical analysis indicator are two lines. The first line represents the difference (delta for you math people) between these two moving averages. The second line is an exponential moving average (usually set to 9 periods) of the difference between the two moving averages and is the slower of the two.

Stop With The Math Already What Does This Mean???

The boiled down version of explaining what the MACD presents to you on the chart is VELOCITY.

The velocity of the trend is what you are looking at and that’s why this is on of the most popular technical indicators and  technical analysis tools used today.

When the MACD crosses above or below the signal line that corresponds to a change in direction of the acceleration. And, since stocks can only move in two directions, up or down, crossover represents a significant event when it comes to interpreting the health of a trend.

MACD Crossing The Zero Line

The MACD Histogram, which represents the difference between the two moving averages, indicates the “acceleration” of the velocity.

MACD Histogram Bars With Breakout Signals

So in essence, the MACD Indicator shows you the trend direction and the current acceleration of that trend.

Now let’s take a look at the different ways you can set up your charts to look at this indicator…

MACD Chart Types

When it comes to setting up your charts to use this indicator you have several options on most charting and trading platforms.

I happen to use ThinkorSwim’s desktop trading application which has ample ways to use this and pretty much any other type of indicator you can dream of.

Here are some of the options for setting up this indicator in ThinkorSwim…

Probably the most popular way to view the MACD Indicator is with two lines and a histogram.

MACD Histogram with 2 Lines:

2 Line MACD With Histogram

This way you can easily see where both lines are in relation to the signal area and whether or not they are moving towards or away from the signal line. You can also use the histogram to visualize the acceleration of the two lines.

Here are some other views you can try…

MACD 2 Line (No Histogram)

2 Line MACD (No Histogram)

MACD Histogram With Breakout Signals

MACD Histogram Only

MACD Histogram

The important thing is that you can set up this indicator and personalize it so that you can easily view the information that is most important to your trading.

Don’t get caught up in thinking there is a “right” way to set up your chart. Just make sure you understand what you are looking at. By that I mean…

What important information does this indicator provide to you that is beneficial to your trading?

If you can’t answer that question you either need to reread how it’s calculated and what you are looking at or, if you do understand it but it’s not beneficial to your trading then don’t include it on your chart for analysis.

Trading Using The MACD Indicator

When it comes to using the MACD Indicator and your Technical Analysis to setup and execute profitable trades there are many different strategies you can use.

The simplest of these strategies involves a MACD Signal when it crosses the zero line.

Zero Crossover Strategy

The Zero Crossover Strategy for MACD can be used many different ways. The most important thing you have to understand is that this indicator is best used to grade the velocity of an underlying trend and to use that information to determine if the trend is strong or if it is in fact weakening.

So, the first thing you have to determine is are you a trend trader or are you a counter trend trader?

Hopefully after learning about Technical Analysis you understand that “The Trend Is Your Friend.”

Understand that while this statement is true for trend traders, there also plenty of profitable counter trend traders as well. The good thing is both types of traders can use the MACD Indicator to help setup and execute their trades.

For the trend trader, you can use the Moving Average Convergence Divergence Indicator in two very important ways.

Number one, no matter whether you are setup to profit from price in an uptrend or price in a downtrend you should use the MACD to confirm that trend. It’s simple.

Here’s how…

Bullish Trend Trade

MACD Confirms Uptrend

If you are looking at entering a trade in an uptrending market then you want to see both lines of the MACD above the zero line. As you learned earlier, when both lines are above the zero line that indicates that the velocity of price is moving in the direction of higher prices. This confirms the uptrend you are targeting and now you just have to pinpoint your entry.

Bearish Trend Trade

MACD Confirms Downtrend

On the contrary, if you are looking to enter a trade to profit from a downtrending market then you want to see both MACD lines below the zero line. Again, this tells you that the velocity of price is in a downward direction which confirms the downtrend.

On the other hand if you are a Countertrend Trader, then you can use the MACD Indicator Histogram instead of the Zero Line…

Histogram Crossover Strategy For Counter Trend Traders

If for some reason you are looking to trade against the trend then you will need a faster signal to get into and out of your trade. Instead of using the two lines crossing the zero line you can use the histogram crossing the zero line instead.

Remember, the histogram quantifies the difference between both lines.

Bullish Counter Trend Trade

As a counter trend trader you will be looking to profit when price temporarily reverses away from the trend. For a bullish counter trend trade you will be looking for a downtrend in price where the MACD Histogram crosses above the zero line. Using the histogram will give you a faster signal which is needed for short counter trends. With counter trend trading you don’t have much room for error so be sure to have a strict trading plan in place.

Bearish Counter Trend Trade

For a bearish counter trend trade your setup will start with an uptrend in price. Again look for the MACD Histogram to drop below the zero line indicating a change in trend. When designing this type of trading plan you can look to the crossing below and above the histogram as an entry or exit.

Needless to say there are many more ways you can setup trades using the MACD Indicator. Check back often for updates to this post and a future MACD Trading Plan.

In the meantime, here’s some more information about this powerful technical indicator

MACD Indicator Pro’s and Con’s

• Pro’s
• Easily identify strength of underlying trend
• Identify weakening trends
• Like all indicators you can customize the settings to the current market environment
• Con’s
• Loses effectiveness in non trending markets
• Lags market due to use of lagging indicators like moving averages

Read the site’s Disclaimer for more details but this site is dedicated to helping educate traders and investors with the knowledge of as many Technical Analysis tools as possible. The Moving Average Convergence Divergence (MACD) Indicator is just one of these tools and the illustrations above are just that, illustrations. Use the knowledge, educate yourself, find successful ways to apply this knowledge, become responsible for your trading, and achieve.