MACD Divergence

Positive MACD Divergence on IWM*

MACD Divergence typically means a divergence between the MACD technical indicator and price. The name MACD divergence is a little confusing and new traders are inevitably unclear about the definition of a MACD divergence or, most importantly, how to recognize one. Once identified, the next question is how long after the MACD divergence signal does it remain a consideration in the analysis of price action. Finally, or (perhaps initially to know why we might care) , what kind of performance might a trader expect from a MACD divergence — win rates, expectancy, drawdowns, tendency to jump stops - these are all important considerations to a trader selecting an indicator or strategy.

Naming

MACD spells out to Moving Average Convergence Divergence. Adding another divergence on the end of all that may at first seem redundant but really it means that two sets of things are diverging. The first “Divergence” built into the MACD acronym refers to the movements of the two moving averages that form the basis of the MACD. (The MACD itself is the difference between two moving averages of price, usually the 12-day EMA and the 26-day EMA. ) The second “divergence” in MACD divergence refers to a disparity between the price action and the movements of the MACD indicator.

Identifying a MACD Divergence

The basic characteristic of the MACD divergence is that the indicator does not confirm price action. If the price makes a new low but the MACD indicator makes a higher low, that is called a positive MACD divergence. On the other hand, if price makes a higher high but the indicator makes a lower high, that is called a negative divergence. Sounds simple enough but in practice there are subtleties such as the appropriate time between extremes of price. Further, some traders will look for specific characteristics in the divergence such as minimum or maximum price differences between the price extremes or the slope of the price trend at the time of the divegence. This adds complexity to the identification process.

An efficient way to identify MACD divergences is to use a software scanner that can identify which stocks, ETFs, or other instruments are experiencing a MACD divergence at the right edge of the chart.

Red arrows highlight the negative MACD divergence on this StockFinder chart of THS at right.

Persistance of a MACD Divergence

Some traders may look at a divergence as an occurrance that impacts an entire trend. Others may consider that the MACD divergence is only in force until the MACD Histogram moves in the opposite direction. One way to settle the debate among traders about how long a MACD divergence remains a factor is to back test different scenarios and compare them.

Performance of a MACD Divergence

For a high-level comparison of the historical performance of the MACD Divergence to other MACD signals visit the Truth About MACD site and check out the free stuff. For the actual historical stats from our large-scale back test, read the BackTesting Report #8: Finding Big Bottoms with MACD Divergence, which is part of the Truth About MACD series. Only with a solid understanding of the strengths and weaknesses of the MACD divergence can a trader hope to make the best use of it.

* IWM is the ETF of Russell 2000