What is MACD in Stocks? MACD oscillator explained, plus examples

What is MACD in Stocks?

Like most momentum indicators, it can be a valuable tool in volatile markets, but is also prone to false signals, and you need to use it properly. In this article, you will learn how to read MACD, how to calculate it, and why using MACD for stocks can benefit short-term traders.

How and why traders use MACD

So what is MACD in trading, anyway? In short, the MACD is an oscillator that uses moving averages to draw lines on your typical stock chart. The lines on the oscillator often converge and diverge (hence the name), creating trading signals based on short-term momentum.

For example, a trader may have a stock alert triggered by a specific crossover of the MACD components. MACD can be used for bearish and bullish signals, making it a favorite choice among all traders.

Why do traders like to use the MACD indicator? Here are some reasons:

Versatility: The MACD can trigger bearish and bullish signals over a wide range of time frames, so day and swing traders find it useful on many tradable assets. In addition, the MACD has momentum and trend-following indicators properties, which make it useful for different strategies.
Simplicity: The MACD definition is quite easy to understand. It uses clearly named parameters, and the signals come from easily identified crossover patterns. Beginner day traders often start learning about technical tools through MACD as it combines several useful concepts and does not require a math Ph.D. to interpret.
Useful on timeframes and asset classes: We will discuss a MACD stock chart in this article, but the indicator is not only for stocks. Since it uses moving averages to send signals, the MACD can also be useful for assets such as forex and commodities trading. It’s also customizable – you can use it on daily, weekly or monthly timelines.

How to calculate MACD

What is MACD calculated as? The indicator has a simple formula to create two lines and a histogram. To calculate the MACD, you need to find three different moving averages. MACD uses exponential moving averages (EMA) over simple moving averages (SMA) because EMAs give more weight to the most recent price data, helping traders find short-term signals.

First, you need to find the MACD line. This line is found by first calculating the 26-period EMA and the 12-period EMA. Most traders use days as their period, but you can use any period. So, take the 26-day EMA and subtract the 12-day EMA – this is your MACD line. The MACD line helps the market trend and how much momentum that trend may have.

Next, you will plot the nine-day EMA of the MACD line against the MACD line itself. The nine day EMA of the MACD line will act as your signal line. (Don’t worry, most brokers will have their MACD tools set this up automatically.)

If the MACD line drops below the signal line, it is often considered a bearish signal. On the other hand, if the MACD line rises above the signal line, it is a bullish signal. Here is an example of the MACD on the NVDA Corp. NASDAQ:NVDA stock chart:

The blue line on this chart represents the MACD calculation, and the orange line represents the signal. Of course, you may also be wondering what the map’s green mountains and red valleys are. The peaks and valleys along the center line represent the divergence between the MACD and signal lines (known as the MACD histogram).

For example, look at the large green area on the NVDA map. The green signals bullish momentum, but the size of the area shows that the MACD and signal lines have become unbound. Usually these lines follow each other closely, but when they start to diverge, the histogram becomes more pronounced.

How to interpret MACD

The beauty of the MACD lies in its simplicity, but you’ll still need a solid understanding of how it works to properly interpret it. There are several signals to register from MACD, and traders need to understand which ones to look for. If you are bearish on a particular stock, a bullish momentum MACD crossover might not throw a tick on your radar.

The MACD indicator consists of three components: the MACD line, the signal line and the histogram, with the histogram anchored at the center (sometimes known as the zero line). The MACD line and the signal line can identify trading signals, but the histogram is also an important piece of the puzzle because it can show the strengths or weaknesses of the current trend.

For example, when the MACD line and signal line start to diverge, the histogram will grow depending on the direction of the trend. If the divergence occurs during bearish price action (ie the MACD line continues to move below the signal line), the red valley on the histogram becomes larger. The stronger the divergence, the more prominent the histogram will become.

The histogram will shrink to the zero line as the MACD and signal lines converge again.

Why is this interpretation important? Because, like any indicator, the MACD is not perfect and can send false signals. Since the calculation is constructed with past stock price data, the MACD is considered a lagging indicator, meaning that not every signal will result in the expected price action. One of the ways the histogram helps traders is by showing the trend strength along with the actionable signal. For example, if the MACD line begins to decline toward the signal line during an extremely bullish period, it may indicate that the trend momentum is reversing. However, this could also lead to a false signal as the current bullish trend continues to feast on momentum.

In the section below, we will dive into some specific scenarios where the correct interpretation of the MACD can lead to profit opportunities. Remember to confirm any MACD signal with other technical tools before entering any positions. Since MACD does not identify overbought or oversold markets, its signals should be compared to other indicators to maximize accuracy (and minimize losses).

Examples of MACD

If you look at the graph of Alphabet Inc. NASDAQ: GOOG on MarketBeat, you can convert the MACD indicator and have it appear in the sub-chart below the stock price. The formula will already be executed, so you don’t need to worry about calculating the 26-day EMA and subtracting the 12-day EMA from it. The chart below shows the MACD line and signal line crossing alongside the three-month chart and the histogram, which become larger when the two lines diverge. You can also see how the indicator is sending signals by looking at the area around July 24th.

If you were bullish on GOOG stock, the third week of July presented a great opportunity. The stock has been bouncing around for most of the month, but the volatile trade was about to end, and bullish momentum was ready to return. Around July 24, the MACD line crossed over the signal line and started to move upwards, creating a large divergence between the two lines. If the crossover triggered one of your trading signals, you could have bought GOOG shares for around $120 and rode the momentum into the upper $130s in less than six weeks.

Crossovers and divergences

Two very important concepts to understand when using MACD are crossovers and convergences. A crossover can occur when the MACD line crosses the signal line and when the MACD line crosses over the zero line. Crossovers far from the zero line tend to be stronger than those closer to the zero line. Divergence can happen when the MACD sends a signal contrary to the current price movement or when the MACD and signal lines start to move apart, which can be a signal for a market that is quickly gaining momentum.

The above five-day GOOG chart comes from one of MarketBeat’s many tools and calculators. In the yellow highlighted area, you will see that price action is becoming volatile while the MACD line has started to descend towards the zero line. This could be a bearish signal, with MACD signifying a potential bullish trend reversal. Indeed, the stock price quickly lost bullish momentum at this point, and a trader who noticed this crossover could have profited from a short position.

In the green marked section, a bullish signal appears while the MACD and signal lines are below the zero line. Here, the MACD line crosses over the signal line as price begins to recover, often indicating a break in bearish momentum. After the crossover here, GOOG stock price started a rise that did not disappear until the MACD crossed over the signal line and began to head down towards the zero line.

MACD: Useful, but use it as part of a larger toolkit

The MACD indicator is one of the most popular technical trading tools because it is easy to understand, easy to calculate and provides clear signals that can easily trigger automated alerts or systems. MACD can be used by day traders or swing traders, making it a more versatile technical analysis feature. You can also find the crossovers in bear and bull markets, and MACD can work across multiple asset classes such as stocks, currencies and commodities.

However, the MACD is not without its flaws. Because it is a lagging indicator, not every crossover signal will be actionable. Many false signals will occur, especially when markets are swinging around and trends are struggling to gain steam. A range bound market or complacent market is not ideal for tools like MACD.

To maximize you trading success, use tools like MACD in good situations and also use it in conjunction with other indicators. One indicator that is often used side-by-side with MACD is the Relative Strength Index (RSI). RSI is another momentum indicator used to identify overbought and oversold conditions. Since MACD tends to predict false breakouts, using another indicator like RSI to confirm the signal can save time, money and mental anguish.