Before I begin the analysis I wish to label each part of the MACD Indicator to avoid any confusion. The indicator has three parts that each work together. First we develop the MACD line, this is the indicator that may be providing the difference between the 12 bar as well as the 26 bar moving average that you just see on the chart. The only purpose of the MACD line is always to show you a visual representation in the difference between the two moving averages.
The center line crossover is just about the most popular methods of using the MACD Indicator. A bullish center line crossover occurs when the MACD moves above the zero line and turns positive. This happens when the 12-day EMA of the main market moves above the 26-day EMA. A bearish crossover occurs when the MACD moves below the zero line to show negative. This happens when the particular 12-day EMA moves below the particular 26-day EMA.
The next line would be the Signal Line. The sole purpose of the Signal Line is to generate a smoothing of the MACD Line. The Signal Line creates a moving average in the MACD line. If you recall in yesterday's tutorial I demonstrated the basic principles of trading MACD Line along with Signal Line crossovers.
The next section of the MACD Indicator is the Histogram. This can be simply the visual representation in the difference between the MACD Line as well as the Signal Line. The wider apart the MACD Line moves far from the Signal Line the more activity you will observe on the Histogram. If there is very minimal distance between the MACD Line as well as the Signal Line then you would see very minimal action on the Histogram.
Make sure you look at the MACD Indicator as an external and internal indicator. Meaning the MACD Line shows what is currently happening when it comes to market price. However, the Signal Line as well as the Histogram are internal and only react to the indicator and not the marketplace. I call the Signal Line as well as the Histogram indicators for another indicator.
In today's exercise we probably will not be using either the Signal Line or the Histogram so you just need to focus on the MACD Line. I'm going to turn with both of the moving averages to help you see how the Center Line crossover signal is generated.
The main point I want you to definitely get from this exercise is the Center Line crossover is merely another way of analyzing a self-explanatory exponential moving average crossover without having to use the moving average indicators. Here is one chart with both fast and the slow moving average as well as the MACD Indicator below. You can see how every time the MACD Line crossover either above or below the middle Line the EMA's above cross at the very same time. I hope that takes a lot of the mystery out of the MACD indicator.
Take note of the Moving Averages and notice what happens each time they cross each other both on the way up and on the way down. Each time the moving averages cross the other the MACD Line crosses either above or below the middle Line. Center Line is a middle ground zero area and every time the MACD Line moves north in the Center Line it means the short term or fast moving average has crossed above the particular slow moving average. In our case the 12 day moving average would be the fast moving average and the particular 26 day moving average would be the slow moving average. Conversely, each time the MACD Line moves south in the Center Line the slow moving average has crossed above the fast moving average and so the trend turned down.
Remember that the MACD should be looked at as two different indicators. An external indicator that reflects price and an internal indicator that reflects what the particular MACD does and avoids selling price completely. By understanding each section of the MACD you can begin to determine how all the pieces communicate.
Tomorrow I will show you how to modify the MACD and some actual examples to help you put the MACD Indicator to make use of.