MACD is an acronym for Moving Average Convergence Divergence.
On a MACD chart you will usually see three numbers that are used for its settings.

• The first one is the number of periods used for the faster moving average.
• The second one is the number of periods used for the slower moving average.
• The third one is the number of bars used to determine the moving average of the difference between the faster moving average and the slower moving average.

 

The most common setting for MACD parameters is "12, 26, 9", these values ​​being interpreted as follows:

• 12 - represents the number of last bars for which the fast moving average is calculated (in the example above it appears in blue).
• 26 - represents the number of last bars for which the slower moving average is calculated (red appears in the example above).
• 9 - the number of bars for which the difference between the two mobile averages above is calculated. This is graphically represented by vertical lines called histogram (vertical green and red lines in the graph).

There is a general misconception when it comes to MACD lines.
The two lines are not mobile averages. Instead, they are the moving averages of the difference between the two mobile averages.

The slower moving average divides the average of the previous MACD line.

Again, from our example above, this would be a moving average of 9 periods. This means that the fast moving average of the last 9 periods of the MACD line is divided to our slower mobile average.

If we look at our original chart, it can be noticed that since the two moving averages separate, the histogram becomes larger. This is called divergence, because the faster average is "divergent" or moving away from the slower average
then the moving averages approach each other, the histogram becomes smaller. This is called convergence, because the faster average is "converging" or moving closer to the slower average.
Hence the name of the indicator - Moving Average Convergence Divergence.

Use of MACD in trading

Because there are two moving averages with different "speeds", the fastest reacts earlier to price movements. When a trend change occurs, the fast line will react more quickly and eventually break through the slower line.
When this happens - the "intersection" - and the fast line begins to move away from the slower line, the formation of a new trend is signaled.




From the graph above, it can be seen that the fast line has passed below the slow line and a downward trend has been formed. Note that when the lines cross the histogram temporarily disappears. This is because the difference between the lines at the time of crossing is 0.

As the descending trend begins, the fast line diverges away from the slow line, the histogram becomes larger, which is a good indication of a strong trend.

There is a disadvantage to MACD. Naturally, mobile averages tend to remain behind the price. After all, it's just an average of historical prices.
Since MACD is a moving average of other mobile averages, that are virtually smoothed, you can imagine that there is a slight delay.

Another way of identifying a new trend or confirming the continuation of the current one with MACD indicator is by using divergences.

Divergences are formed when there is a discrepancy between the price and the technical indicator.
This discrepancy is often observed in oscillators - ex: RSI, MACD, CCI Slow Stochastic etc. Indeed, these indicators give the best signals when they form differences to price movement.

So an early indication of impulse change is given by divergence, and a change in impulse is often the main indication for a trend shift.

There are three types of divergences:

• Regular - is a signal of trend-change, indicates that the existing movement is close an to end and we can expect a Swing High or a Swing Low.
• Hidden - they are a signal of continuity.
• Continously - they are a signal of a corrective movement of the price.

Regular  Divergence - the two hypotheses
 

• The price forms Higher Highs and the indicator (MACD signal lines) forms Lower Highs - indicates a downward reversal. This is a Bearish divergence.

 

• The price forms Higher Lows and the MACD histogram forms Lower Lows. - it is called Bullish divergence, meaning that the ascending trend will continue.

 

 

• The price forms Lower Highs and the MACD histogram forms Higher Highs. - it is called Bearish divergence, meaning that the descending trend will continue.

Continously Divergence - the two hypotheses
 

• The price forms Higher Highs and the MACD histogram forms Lower Highs - indicates a corrective movement of the price from upward to downward (descending).

 

• The price forms Lower Lows and the MACD histogram forms Higher Lows - indicates a corrective movement of the price from downward to upward (ascending).