MACD (Moving Average Convergence Divergence) is probably the most famous trend following indicator, developed by Gerald Appel. The indicator is primarily the difference between the two Moving Averages, coupled with a further smoothing up of the result. Appel himself considered the most effective parameters to be 12, 26 and 9.

Hence the formula looks like this:

MACD Line = (12 day EMA – 26 day EMA) and the Signal Line = 9 day EMA of MACD Line

Many traders prefer using the Histogram form of the indicator which is plotted on the chart as the difference between the MACD line and the Signal line.

MACD

Advantages And Limitations of MACD

This indicator combines both the advantages of a trend following indicator and a momentum oscillator. The natural states of a momentum oscillator like the overbought or oversold can be used easily here, though the levels can’t be that rigidly defined as the indicator is confined inside any fixed band. Still, the more popular trading techniques follow Divergences or the indicator falling out of sync with the price and Crossover or the Signal Line crossing above/below the MACD Line triggering trades. The major limitation of the indicator emerges from the fact that the values of the indicator is dependent on the price of the underlying.

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