(by John Lansing)
The Moving Average Convergence/Divergence, or MACD, is useful chart indicator, which shows the relationship between two moving averages of prices.
The MACD is the difference between a 26-day and 12-day exponential moving average. A nine-day exponential moving average called the "signal line" is plotted on top of the MACD to show bullish and bearish signal points.
A bullish signal is generated when the MACD rises above the signal line, or above zero. A bearish signal occurs when the MACD falls below the signal line or below zero.
The MACD is best used in strongly trending markets (i.e., when there is a sustained direction, either up or down, for a period of time) because it indicates overbought and oversold conditions.
An overbought situation occurs when prices have risen too far too fast and are ready for a downward correction.
An oversold situation occurs when prices have fallen too far too fast and are ready for an upward correction.
When the shorter moving average pulls away from the longer moving average (i.e., the MACD rises), it is likely that the financial instrument's price is too high and will soon return to more realistic levels.
An indication that an end to the current trend may be near occurs when the MACD diverges from the security's price.
A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. A bullish divergence occurs when the MACD is making new highs while prices fail to reach new highs.
Both of these divergences are most significant when they occur at relatively overbought/oversold levels.