MACD Indicator | How Does It Work? | Definition & Examples
MACD is a technical indicator designed to help investors identify price trends, measure trend momentum, and identify acceleration points to fine-tune market entry timing (whether you’re buying or selling).
How does MACD work?
The MACD indicator has many moving parts and functions, but it’s made up of three general components: the MACD line, which is the difference between two moving averages; a signal line, which is a moving average of the MACD line; and a histogram.
MACD takes the moving average concept a step further. It’s one thing to compare a fast and a slow moving average, but for MACD, that’s only the beginning.
First, the MACD line is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA (i.e., fast minus slow). Why? The calculation is designed to show the relationship between the two averages, and it does so in a way that places emphasis on more recent price data.
The signal line is a 9-day (or 9-period) EMA of the MACD line. In other words, it’s a moving average of the difference between two moving averages, or a “slower” version of the difference between a fast and a slow moving average.
Why use a moving average of two other moving averages? The signal line calculation “smooths out” the MACD line, creating an even slower moving average that serves as the faster MACD line’s counterpart.
How do you read the MACD?
Pay attention to the moving averages—the MACD and the signal line—and their relation to the histogram.
Note that when the MACD line (the faster moving average) is above the signal line, the bars in the histogram are above the zero line, which is a bullish signal. When the MACD line is below the signal line, the histogram bars are below the zero line, which is generally bearish.
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