Moving average difference

The MACD indicator is based on moving averages but provides some additional indications that can help to refine your analysis. To understand the principle of the MACD consider figure 6.1 (overleaf).

Figure 6.1: moving average difference

This diagram illustrates a typical price wave sequence with the price changing from downtrend to uptrend and back to downtrend again. I’ve shown two moving averages: a shorter term one (thinner line) and a longer term one (thicker line), and I’ve marked the moving average golden cross and dead cross crossover signals. You can see that there’s a time lag between the price trend change and the moving average crossover, which I’ve also marked on the diagram.

If you examine the separation between the two moving averages, you can see that there’s an indication of a trend change some time before the crossover point. At the left side of the diagram the moving averages converge as the downtrend falters and then cross — a golden cross buy signal. After the crossover they diverge as the uptrend gathers pace, then converge again as the uptrend falters until they give a dead cross sell signal. After the crossover they diverge again as the downtrend gathers pace.