Most traders use indicators in their trading. However, very few actually know how the indicator came to be, let alone what information the indicator uses to make its calculation. When using tools of the trade, it’s important to understand where it derived from. If you are unaware of its purpose, then you are doing yourself a disservice. Always know what you are using and why you are using it.

You may have heard of MACD. It is short for Moving Average Convergence/Divergence. It is an indicator that has been around for nearly a half of a century. Renowned trader and financial author, Gerald Appel created it to help define trends.

MACD shows the difference between two moving averages. Generally one is a fast moving average, while the other one is slower. The larger the difference, the stronger the trend one can expect.

During the 60’s, Sappel used EMA 12 and EMA 26. So to calculate the MACD, you would subtract the slower moving average from the faster. The total would be the MACD. Once this convergence/divergence was calculated, a trigger was needed to enter the trade. The 9 EMA of the MACD itself was designed to be the trigger.

To enter or exit trades you would wait for the MACD to cross the trigger price of the MACD’s EMA 9. Another way to trade is to look at the histogram of the MACD. The histogram was calculated by subtracting the signal from MACD. To trade utilizing the histogram, a trader would have to identify divergence in between the histogram and price itself.

A third way to trade it would be to wait for the to cross 0. So if the MACD was coming up through the 0 line, this would be represented as a bullish signal. Likewise a bearish signal would have the MACD line going down through the 0 line.

In the 80’s MACD was extremely popular as it was proving itself to be a reliable trading tool. However, as markets are always changing, in today’s market MACD generates numerous false signals if trading alone. One could even argue that MACD is entirely useless as a trigger signal itself. It does serve it’s purpose however by having an overall view of the market place. MACD is best used on a higher timeframe to get a general idea of a trend. A weekly chart is preferred, however a daily could be sufficient as well.

12, 26, and 9 are standard settings on nearly every trading platform that includes MACD. There are those that have experimented with a variety of different EMA values and have shown positive results. Feel free to experiment with the settings and see if you are able to re-energize MACD back into the forefront of our charting platforms.

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