MACD is an acronym for Moving Average Convergence Divergence. The MACD uses 2 exponential moving averages and while you would only see two lines on your computer screen three lines are actually used in its computation.
The faster line is called the MACD line and it is the difference between two exponentially smoothed moving averages of closing prices (usually the last 12 and 26 days or weeks). The slower line is called the signal line and is usually a nine period exponentially smoothed average of the MACD line.
With a MACD chart, you will usually see three numbers that are used for its settings. The first is the number of periods that is used to calculate the faster moving average.The second is the number of periods that are used in the slower moving average.And the third is the number of bars that is used to calculate the moving average of the difference between the faster and slower moving averages.
For example, if you were to see 12,26,9 as the MACD parameters (which is usually the default setting for most charting packages), this is how you would interpret it: The 12 represents the previous 12 bars of the faster moving average. The 26 represents the previous 26 bars of the slower moving average and the 9 represents the previous 9 bars of the difference between the two moving averages.
MACD Bullish Signals
The MACD generates bullish signals from Positive Divergences, Bullish Moving Average Crossovers and Bullish Centerline Crossovers.
Positive Divergences occur when the MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. The MACD can either form as a series of higher Lows or a second Low that is higher than the previous Low. Positive Divergences are probably the least common of the three signals, but are usually the most reliable, and lead to the biggest moves.
Bullish Moving Average Crossovers
A Bullish Moving Average Crossover occurs when MACD moves above its 9-day EMA, or trigger line. Bullish Moving Average Crossovers are probably the most common signals and as such are the least reliable. If not used in conjunction with other technical analysis tools, these crossovers can lead to whipsaws and many false signals. Bullish Moving Average Crossovers are used occasionally to confirm a positive divergence. A positive divergence can be considered valid when a Bullish Moving Average Crossover occurs after the MACD Line makes its second higher Low.
Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day.
Bullish Centerline Crossover
A Bullish Centerline Crossover occurs when the MACD moves above the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive, or from bearish to bullish. After a Positive Divergence and Bullish Centerline Crossover, the Bullish Centerline Crossover can act as a confirmation signal. Of the three signals, moving average crossover are probably the second most common signals.
MACD Bearish Signals
The MACD generates bearish signals from Negative Divergences, Bearish Moving Average Crossovers and Bearish Centerline Crossovers.
Negative Divergences occur when the security advances or moves sideways, and the MACD declines. The Negative Divergence in the MACD can take the form of either a lower High or a straight decline. Negative Divergences are probably the least common of the three signals, but are usually the most reliable, and can warn of an impending peak.
Bearish Moving Average Crossover
A Bearish Moving Average Crossover occurs when MACD declines below its 9-day EMA. Not only are these signals the most common, but they also produce the most false signals. As such, moving average crossovers should be confirmed with other signals to avoid whipsaws and false readings.
Bearish Centerline Crossover
A Bearish Centerline Crossover occurs when the MACD moves below zero and into negative territory. This is a clear indication that momentum has changed from positive to negative, or from bullish to bearish. The centerline crossover can act as an independent signal, or confirm a prior signal such as a moving average crossover or negative divergence. Once MACD crosses into negative territory, momentum, at least for the short term, has turned bearish.