5 Ways Stock Traders Use MACD as a Technical Indicator

In recent weeks, we've been examining various technical indicators that traders here at Schaeffer's use to determine potential moves in stocks. We've looked closely at Bollinger Band breakouts and moving average crossovers, which Schaeffer's Senior Quantitative Analyst Rocky White identified as particularly strong "buy" signals. Today I asked Schaeffer's Senior Equity Analyst Joe Bell, CMT, to break down another indicator that's often used in trade decisions: MACD.

What is MACD?

JB: MACD is an acronym that stands for Moving Average Convergence Divergence and is a trend-following momentum indicator that shows the relationship between two moving averages of stock prices. It is traditionally used to look for "buy" and "sell" signals based on the momentum of a stock.

How is MACD calculated?

JB: The MACD line is calculated by subtracting the 26-day exponential moving average from the 12-day exponential moving average. The second step is to calculate a 9-day exponential moving average of the MACD line. This second line is sometimes referred to as the "Signal" line and is plotted along the same axis as the MACD line. Some people will adjust the time periods used for these for their individual time frame. Shorter time frames will usually generate more signals, while longer time frames will generate fewer signals.

How do you use this signal in trading decisions?

JB: I generally use the indicator in combination with other technical analysis tools and not strictly as an automatic "buy"/"sell" trigger. But there are several ways traders use the MACD line, including: 

1. When the Signal line moves above the MACD line, the trader buys the stock in anticipation of a continuation of upward momentum.
2. When the Signal line moves below the MACD line, the trader sells the stock in anticipation of a continuation of downward momentum.
3. If the stock price makes a higher high during an uptrend and the MACD line fails to a make a higher high, a bearish divergence occurs and could indicate a potential reversal in trend.
4. If the stock price makes a lower high during a downtrend and the MACD line fails to make a lower low, a bullish divergence occurs and indicates potential for a reversal in trend.
5. Some traders see large moves of the MACD line above/below the 0 line as being a signal of overbought/oversold as well.

Is MACD a particularly strong "buy"/"sell" indicator? Why?

JB: I don't view or rank indicators from best to worst, because they are usually used in combination with other factors and not part of a mechanical trading system by themselves. MACD is one of the tools that I have on all my charts when I am evaluating a company or market. It is a quick way to gauge the current momentum of a stock. I see it as an objective tool to determine the potential momentum of the stock, because sometimes your eyes can play tricks on you when just looking at price alone.