Moving Average Convergence Divergence, or MACD, is a method of technical security analysis intended to both spot price trends and also to verify the momentum of these trends. The MACD is the difference between the 12-day moving average of the price of a particular security and the 26-day moving average. By charting these two averages, investors can practice trading with MACD by buying when the shorter average intersects the longer average in a positive direction and selling when the opposite occurs. In addition, other methods of trading with MACD include using the signal line — a 9-day moving average of the MACD itself — and comparing the MACD to current prices for indicators of trend reversal.
A moving average, which takes the average price of a security over a period of time and moves as new price data replaces older prices, is a popular tool for investors who prefer technical analysis. Technical analysis is the practice of using past price performance to predict future prices. Taking the moving average even further, the MACD tries to spot trends by pitting a moving average of a relatively short period of time against a longer-spanning average.
The most important step in trading with MACD is consulting a chart of the different measurements. For example, charting the two different moving averages will produce different points on the chart where the two lines intersect, so the MACD will be zero. When the 12-day average goes past the 26-day average in an upward direction, it suggests the momentum is building on the security. By contrast, the shorter average moving past the longer going down indicates a possible negative trend.
Another way in which these charts are used in trading with MACD is when a signal line is incorporated. The signal line is produced by taking a 9-day moving average of the MACD itself. This is then plotted against the current MACD. In this case, the theory is that because the MACD includes less lag time, it is a better indicator of the way the security is currently valued by investors.
Charting the MACS against current security prices is another effective method of trading with MACD, especially when attempting to spot a trend reversal. A stock that is trending downward but is headed for a reversal will often chart a much lower bottom point than the bottom point reached by the MACD. In contrast to this, a downward reversal can be suggested when the security price rises past the highest point reached by the MACD.