How to Create MACD

The original MACD indicator consists of two lines: a solid line (called the MACD line) and a dashed line (called the Signal line). The MACD line is made up of two exponential moving averages (EMAs). It responds to changes in prices relatively quickly. The Signal line is made up of the MACD line smoothed with another EMA. It responds to changes in prices more slowly.

Buy and sell signals are given when the fast MACD line crosses above or below the slow Signal line. The MACD indicator is included in most programs for technical analysis. Few traders calculate it by hand — a computer does the job faster and more accurately. To create MACD:

1. Calculate a 12-day EMA of closing prices.

2. Calculate a 26-day EMA of closing prices.

3. Subtract the 26-day EMA from the 12-day EMA, and plot their difference as a solid line. This is the fast MACD line.

4. Calculate a 9-day EMA of the fast line, and plot the result as a dashed line. This is the slow Signal line (see the worksheet, Figure 26-1).

Market Psychology

Each price reflects the consensus of value among the mass of market participants at the moment of the trade. A moving average represents an average consensus of value in a selected period — a composite photo of mass consensus. A long moving average tracks long-term consensus, and a short moving average tracks short-term consensus.

Crossovers of the MACD and Signal lines identify shifts in the balance of power of bulls and bears. The fast MACD line reflects mass consensus over a shorter period. The slow Signal line reflects mass consensus over a longer period. When the fast MACD line rises above the slow Signal line, it shows

Crude Oil

Day

Close

i 12-EMA

26-EMA

MACD

Signal

MACD-hlst

1

20.70

! 20.39

20.46

-0.07

-0.16

0.09

2

20.55

! 20.41

20.47

-0.06

-0.14

0.08

3

20.72

20.46

20.49

-0.03

-0.12

0.09

4

21.03

j 20.55

20.53

0.02

-0.09

0.11

5

21.10

1 20.63

20.57

0.06

-0.06

0.12

6

21.29

! 20.73

'20.62

0.11

-0.02

0.13

7

21.09

i ¿0.79

20.66

0.13

0.01

0.12

8

21.48

i 20.90

20.72

0.18

0.04

0.14

9

21.23

1 20.95

20.76

0.19

0.07

0.12

Figure 26-1. MACD and MACD-Histogram Worksheet

Figure 26-1. MACD and MACD-Histogram Worksheet

To obtain MACD lines and an MACD-Histogram take these steps:

1. Calculate the 12-day and 26-day exponential moving averages of closing prices.

2. Subtract the 26-day EMA from the 12-day EMA to obtain the fast MACD line.

3. Calculate a 9-day EMA of the. fast MACD line to obtain the slow Signal line. Plot both lines to obtain the classic MACD indicator.

4. Subtract the Signal line from the MACD line to obtain an MACD-Histogram.

that bulls dominate the market, and it is better to trade from the long side. When the fast line falls below the slow line, it shows that bears dominate the market and it pays to trade from the short side.

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