Trading Basics – MACD (Convergence/Divergence) – Part 1

Focus: STRATEGIES

No discussion of momentum-based indicators would be complete without a discussion of the MACD or Convergence/Divergence, developed in the late 1970s by Gerald Appel. Speaking at my first technical analysis seminar in 1983, I discussed my early research and modifications of the MACD. It was not widely used at that time, and I demonstrated how it could be used not only on the stock market (the original intention) but also applied to commodities, mutual funds, and individual stocks. Over 20 years later it is now probably one of the most widely used indicators and is the default indicator on many free sites.

In previous articles we have discussed other price-based or momentum indicators such as the RSI, but the MACD can give the trader additional information. What is the MACD? It is essentially a complex, triple moving average system. First, the MACD is calculated by taking the difference or spread between a 26- and 12-period exponential moving average; then, the signal line, which is a nine-period exponential moving average of this difference, is calculated. In past issues we have discussed using weighted moving averages. Exponential moving averages are just one type of weighted average where the most recent data is given more weight using an exponential formula.

The most basic interpretation is that when the MACD is above the signal line, it is giving a positive signal; conversely, when it is below the signal line, it is negative. Traditionally, these were plotted as two lines, but I found that by plotting the difference as a histogram, which I called the MACD-His, positive and negative divergences were revealed.