Chapter 12, Part II. Moving Average Convergence Divergence - MACD Page 3

Chart #1 60-min EUR/USD and MACD (12; 26; 9)
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Pipruit: Well, then. The second line is calculated by software using the same formula of Moving Average calculation. But instead of using close prices as it was in previous part 11 of book, it uses values of (MA1-MA2) during the number of periods that we’ve specified. So, using the same default settings, this line plots average value of (MA1-M2) for 9 periods. So, this is the second line, a?
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Commander in Pips: That’s right.

Pipruit: Cool. Looks like, I’ve got it!
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Commander in Pips: And now is my turn to ask questions. Why in the first line we should calculate MA1-MA2, and not MA2-MA1?

Pipruit: May be I’m wrong, but it reminds me the simple strategy of two MAs crossing, that we’ve already discussed. When fast line (with shorter period) crosses slow line (with longer period) from below and comes above – the trend turns bullish and vice versa. Since MA1 is faster than MA2 –it reacts faster on trend shifting. That’s why we use MA1-MA2, and not opposite.
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Commander in Pips: You’re absolutely right.

Pipruit: Commander and what is a “Signal Line”?
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Commander in Pips: Oh, yes – some software names third MA, that is MACDA and that has 9 periods as default, as Signal Line. This is slower line, and signal of trend shifting will appear when first line penetrates it. That’s why it calls like that. So:

1. Fast line of MACD (usually colored with blue) – MA1-MA2 that you appoint in indicator tweak menu;

2. Slow line of MACD, aka Signal Line (usually colored with red) – MA on (MA1-MA2).

Now is about plotting MACD as a Histogram. Histogram shows the distance between MACD lines – that’s all. So, when the lines come close to each other, i.e. converge – the histogram gets smaller and it’s bars are shorter. That’s correct, because the distance between the lines becomes smaller. And it is called convergence of moving averages.

The opposite is also true – when the distance between lines becomes wider, i.e. lines diverge from each other – the histogram gets bigger, and it is called divergence of moving averages.