MACD - Moving Average Convergence/Divergence
Moving Average Convergence Divergence (MACD) is a momentum indicator which helps in identifying and following the trend. MACD line is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. The 9 period EMA of MACD line is called the MACD Signal line.
MACD Line = EMA(Price, Period(12)) – EMA(Price, Period(26))
MACD Signal Line = EMA(MACD Line, Period(9))
MACD Histogram = MACD Line – MACD Signal Line
A buy signal is generated when MACD line crosses above MACD signal line or MACD Histogram turns positive, and a sell or short signal is generated when the MACD line crosses below the signal line or MACD Histogram turns negative. Normally these signals are taken in the longer direction of the trend.
Divergence:
When the MACD forms highs or lows that diverge from the corresponding highs and lows on the price, it is called a divergence. A bullish divergence appears when the MACD forms two rising lows that correspond with two falling lows on the price, and a bearish divergence appears when the MACD forms two falling highs which correspond with two rising highs in the price.
AS MACD give the absolute differences in the price of an instrument it becomes difficult to compare different instruments to identify the momentum specifically when the price of instruments are on far ends, hence traders use Percentage Prices Oscillator (PPO) to compare different instruments. Comparison is done specifically when someone needs to select the instrument from the basket of instruments. Refer PPO section in Price Oscillator for more details.