Understanding MACD – Moving Average Convergence Divergence
- Identify Trend Shifts with Crossovers
- Monitor Histogram for Momentum Strength
- Spot Reversals with Narrowing MACD Lines
- Adapt MACD to Different Timeframes
Transcript
CA Manish Singh: Hello everyone, and welcome to Chapter 13.
Today we will learn about one of the most widely used technical indicators in trading: MACD, which stands for Moving Average Convergence Divergence. This indicator is built using moving averages and helps identify trend direction, trend reversals, and momentum strength.
What This Chapter Covers: Introduction to MACD
MACD uses a combination of three elements:
- A fast moving average
- A slow moving average
- A signal line, which generates buy or sell cues
On the chart, these components appear as two lines that move closer together, move apart, or cross each other. These behaviours create visual signals that traders use to judge market strength and possible shifts in trend.
Understanding MACD Components
CA Manish Singh: Let us look at this indicator on the chart for clarity.
Once you search for MACD in your indicator list, you will notice three default settings:
- 12 (fast moving average)
- 26 (slow moving average)
- 9 (signal length)
The blue line represents the leading line, which is the 12-period moving average.
The orange line represents the lagging line, which is the 26-period moving average.
The signal line is plotted based on the previous nine candles and acts as a smoother that helps interpret trend shifts.
Below the lines, you will also see histogram bars. These appear as light green, dark green, light red, or dark red bars depending on the charting tool you are using. The histogram represents the difference between the fast and slow moving averages.
How to Read MACD Signals
1. Crossovers
When the blue (fast) line crosses above the orange (slow) line, it suggests a bullish signal. When the blue line crosses below the orange line, it suggests a bearish signal. You will notice that price often pauses, moves sideways, or even begins to reverse around these crossovers.
2. Histogram Length and Colour
A growing histogram indicates the gap between the fast- and slow-moving averages are expanding. A shrinking histogram indicates the gap is narrowing. If histogram bars are becoming shorter, it signals that momentum is weakening and a trend reversal may be approaching.
3. Narrowing Gap Between Lines
When the two MACD lines begin moving closer together, the difference between them is reducing. This narrowing suggests that the current trend is losing strength.
When the narrowing completes and the lines finally cross, the next trend often begins.
Examples on the Chart
CA Manish Singh: Consider a rising market.
The MACD histogram shows strong green bars and a large gap between the two moving average lines. As soon as the histogram starts shrinking and the gap narrows, you will see price begin to pause. If the blue line cuts below the orange line, it confirms the start of a bearish phase.
Similarly, in a falling market, long red histogram bars represent strong downside momentum. As they shrink, the market begins to lose its downward strength. If the blue line crosses above the orange line, the trend may reverse upwards.
MACD works effectively on short timeframes such as 5 minutes and on longer timeframes such as 1 day. The interpretation is the same, but the impact of the signal varies with the timeframe.
How Traders Use MACD
- Investors use MACD crossovers on daily charts to identify major trend shifts in stocks or indices.
- Intraday traders use MACD on shorter timeframes to understand momentum changes and potential reversals within the day.
The key rule is simple:
If the histogram is expanding, follow the existing trend.
The moment the histogram begins shrinking, prepare for a pause or reversal.
Summary and Takeaways
- MACD uses two moving averages to track trend strength.
- Crossovers signal a possible shift in trend direction.
- Histogram expansion indicates strong momentum.
- Histogram contraction warns of weakening trend strength.
- Narrowing of the two lines is one of the earliest signs of a potential reversal.
- MACD is time-dependent, its behaviour changes with each timeframe.
MACD is one of the most used indicators and can act as a strong confirmation tool alongside price action and other indicators.
In the next chapter, we will begin exploring the instruments used for trading, how they function, and how you can apply them in your decision-making.
Disclaimer: Investments in securities markets are subject to market risks. Read all related documents carefully before investing.