MACD stands for Moving Average Convergence and Divergence. MACD is a calculated by subtracting fast Exponential Moving Average and a Slow Exponential Moving Average. These average moves towards and away from each other and hence the name was given as Moving Average Convergence and Divergence. Mr. Gerald Appel invented MACD in the late 1970s. MACD is so popular because it is one of the most reliable and easy to use technical indicator. Even though it is lagging indicator, it provides signal before moving average cross over. MACD gives signal for trend continuation and reversal therefore used both by bulls and bears.
EMA used to calculate MACD
Any any two EMA(Exponential Moving Average) can be used to calculate MACD but most common are 26 and 12 EMA.
Major component of MACD
1. MACD line. Its a graphical representation of difference of fast exponential moving average and slower Exponential moving average.
2. MACD Signal line is 9 period EMA of the MACD line.
3. Zero Line. It is constant line with default zero line. It also acts as signal line.
4. MACD Histogram- It is plot of difference between MACD line and signal line.
Advantages of MACD
a. It is solid indicator that helps to identify stock trends.
b. It provides signal much before moving average crossover.
Disadvantages of MACD
a. It being an lagging indicator it gives signal after trend has started.
b. In volatile market it gives too many wrong signal.
c. MACD price divergence by many is considered as unreliable as it depends on derivative of derivative therefore it is much far from its base.