Moving Average Convergence Divergence (MACD) is a momentum indicator, hence has pretty much the same features with RSI except that MACD is smoother and signals longer term reversal by divergence.
Below is how we construct MACD, signal line and MACD histogram:
- First derivative: 12-day EMA and 26-day EMA
- Second derivative: MACD (12-day EMA less the 26-day EMA)
- Third derivative: MACD signal line (9-day EMA of MACD)
- Fourth derivative: MACD-Histogram (MACD less MACD signal line)
To keep it simple, analysts call this indicator MACD despite the fact that MACD is only one of the three used in this indicator.
As is the case with RSI, MACD gives us a very powerful signal that is Divergence. However, in MACD we have 2 types of divergence: Peak-trough Divergence and Slant divergence.
a) Peak trough divergence
Peak trough divergence is pretty much the same with the one of RSI. However, in MACD, we can spot the divergence between either
• Price and MACD ( same with RSI)
• or MACD and MACD histogram
b) Slant Divergence
As the name implies, there is no well-defined trough or peak. There is only a slant-lower as MACD histogram moves toward 0 when MACD continues to make new high/low. The signal generated from a slant divergence has exactly the same meaning with Peak-trough divergence.
2) Buy/sell signal
When MACD cross the signal line from the below, we have a buy signal. When MACD cross the signal line from the above, we have a sell signal. You should be very familiar with this type of signal by now. However, these kind of signals are lagging far behind the price so traders should be aware of it before using.
MACD also has the ability to give Overbought/Oversold signal however it is extremely difficult to use. That’s the reason I won’t mention it in this article. There is no reason to make it harder for yourself when you can simply use RSI for overbought/oversold signal. The most precious signal provided by MACD should be the Divergence as MACD has historically pinpointed a lot of major peaks and troughs in the market.