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What is a Moving Average Convergence Divergence (MACD)?

Moving Average Convergence Divergence (MACD) is a technical analysis indicator that is used to identify changes in the trend of a stock or security. It is a momentum oscillator that uses moving averages to measure the strength and direction of a trend. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA.

The MACD line is then plotted against a signal line, which is a 9-day EMA of the MACD line. When the MACD line crosses above the signal line, it is considered a bullish signal, indicating that the security is likely to rise. Conversely, when the MACD line crosses below the signal line, it is considered a bearish signal, indicating that the security is likely to fall.

In addition to the MACD line and the signal line, the MACD also includes a histogram that is used to visualize the difference between the MACD line and the signal line. The histogram is calculated by subtracting the signal line from the MACD line. When the histogram is positive, it indicates that the MACD line is above the signal line, and when the histogram is negative, it indicates that the MACD line is below the signal line.

The MACD is commonly used by traders and investors to identify changes in momentum and to make buy and sell decisions. It is also used to confirm other technical indicators, such as trendlines and support and resistance levels. However, it is important to remember that the MACD is not a standalone indicator and should be used in conjunction with other technical analysis tools to get a complete picture of market trends and conditions.

Simplified Example

Imagine you have a special toy that you love to play with, like a toy car. Every day, you play with the toy car for different amounts of time. You want to know if you are playing with the toy car more or less often than you did in the past.

To keep track of this, you decide to keep a record of how long you play with the toy car each day. You also want to see if the amount of time you play with the toy car is changing over time.

To do this, you make a chart that shows the average amount of time you play with the toy car over the past three days. Every day, you add the new information to your chart and recalculate the average to see if the trend is going up or down.

This is similar to what the Moving Average Convergence Divergence (MACD) indicator does. It helps you see the overall trend in the data, like how often you play with the toy car, by averaging the data over time and showing you if the trend is going up or down. By looking at this information, you can make decisions about whether you are playing with your toy car more or less often than in the past.

Who Invented the Moving Average Convergence Divergence (MACD)?

In the late 1970s, a technical analyst named Gerald Appel sought to tame the wild beast of the markets. He envisioned an indicator, a crystal ball of sorts, that would not only reflect price movements but also whisper their secrets. This quest led him to craft the Moving Average Convergence Divergence, a dance of lines on a chart that would become known as the MACD.

Examples

Bollinger Bands: Bollinger Bands are volatility indicators that use a moving average and standard deviation to create a range that is plotted above and below a stock's price. When the stock price moves outside of the Bollinger Bands, it can indicate a change in the stock's volatility and potential trend reversal.

Relative Strength Index (RSI): RSI is a momentum oscillator that compares the magnitude of a stock's recent gains to the magnitude of its recent losses and calculates a value between 0 and 100. It uses a 14-day moving average in its calculation. If the RSI value is above 70, it is considered overbought and may indicate a potential trend reversal. If the RSI value is below 30, it is considered oversold and may also indicate a potential trend reversal.

Moving Average Envelopes: Moving Average Envelopes are volatility indicators that use a moving average and a percentage deviation to plot lines above and below the moving average. When a stock price moves outside of the Moving Average Envelopes, it can indicate a potential trend reversal. The percentage deviation used in the calculation of Moving Average Envelopes can be adjusted to suit the investor's individual risk tolerance.

  • Average Directional Index (ADX): A technical indicator used to measure the strength of a trend in a financial market.

  • Relative Strength Index (RSI): A technical analysis indicator used to assess the strength of a security's price action.