Why MACD Divergence Can Be An Unreliable Signal

5/1/2020 Why MACD Divergence Can Be an Unreliable Signal
TECHNICAL ANALYSIS TECHNICAL ANALYSIS BASIC EDUCATION
Why MACD Divergence Can Be an Unreliable

Signal
By CORY MITCHELL | Updated Dec 4, 2019
TABLE OF CONTENTS
What Is Indicator Divergence?
Problems With MACD Divergence
Use Price Action w/Divergence
The Bottom Line
EXPAND +
MACD divergence is discussed in most trading books and frequently cited as the reason for
trend reversals, or why a trend could reverse. In hindsight, divergence looks great; many
examples can be found where a reversal was preceded by MACD divergence.
Advertisement
https://www.investopedia.com/articles/active-trading/100115/why-macd-divergence-unreliable-signal.asp 1/13
Look closely though, and you'll find that many reverses aren't preceded by divergence, and
often divergence doesn't result in a reversal at all. So before assuming that divergence is a
Advertisement
reliable tool to use in your trading, let's dig deeper into what MACD divergence is, what
causes it and how to improve the use of divergence.
Advertisement
Advertisement
KEY TAKEAWAYS
MACD is a popular technical indicator used by traders across many different
markets, however its usefulness has been questioned.
One of the main problems with divergence is that it can often signal a possible
reversal but then no actual reversal actually happens – it can produce a false
positive.
The other problem is that divergence doesn't forecast all reversals. In other words,
it can predict too many reversals that don't occur and not enough real price
reversals.
What Is Indicator Divergence?

Indicator divergence is when an oscillator or momentum indicator, such as the moving
average convergence divergence (MACD) indicator, doesn't confirm the movement of price.
For example, a stock price makes a new high while the MACD or relative strength index
(RSI) indicator makes a lower high.
SPY weekly chart uptrend with MACD divergence
Figure 1: SPDR S&P 500 ETF Weekly Chart Showing MACD Divergence During Uptrend
Figure 1 shows an example of divergence during an uptrend. The price continues to trend
higher, but the MACD on several occasions does not make new highs and instead creates
lower highs.
Indicator divergence is meant to show that momentum is waning during a trend and is

therefore more susceptible to a reversal. However, divergence is not good at timing when a
reversal will occur, as Figure 1 shows. As early as 2012, divergence was present on the chart,
even though the uptrend continued into 2015, with significant pullbacks in late 2014 and
2015. This is bearish divergence: when the indicator is making lower highs while the price is
making higher swing highs.
Bullish divergence occurs when the price is making lower swing lows while the indicator is
making higher lows. It is meant to show that selling momentum is slowing and that the
downtrend is more susceptible to a reversal. Figure 2 shows bullish divergence; the lows
in MACD are rising while the price continues to fall. Despite the presence of divergence
between mid-2013 and late 2015, the price continued its downtrend.
GLD weekly chart downtrend with MACD divergence
Figure 2: SPDR Gold Trust Weekly Chart Showing MACD Divergence During Downtrend
Common Problems With MACD Divergence

One of the main problems with divergence is that it often signals a (possible) reversal but no
actual reversal occurs – a false positive. The other problem is that divergence doesn't
forecast all reversals. In other words, it predicts too many reversals that don't occur and not
enough real price reversals.
We'll cover how to handle these problems in the next section. First, here are two common
causes of false positives – divergence that almost always occurs in certain situations but
won't necessarily lead to a reversal.
Divergence will always occur when there's a sharp (big movement in a short amount of time)
move followed by less sharp movement. This is actually what divergence is meant to
capture, as many traders believe that if price movement slows down it's poised for a
reversal.
Figure 3 shows a stock gapping higher and then accelerating to the upside. This rapid and
large price move causes the MACD to jump, and since the price can't continue to keep
gapping higher, divergence occurs. The divergence in this case doesn't indicate a reversal,
just that the price movement is slower than the price movement (gap higher) that caused the
indicator to jump. The gap caused an unusual jump in the indicator, so as the price returns to
more "normal" behavior, divergence occurs. Each price wave of a trend is different, and not
all price waves will move rapidly in a very short amount of time. In this case, the jump in
price was followed by a slower price rise, resulting in a declining MACD reading but not a
reversal.
AAPL daily chart with false positive divergence
Figure 3: Apple Inc. Daily Chart Showing 'False Positive' Divergence
After a sharp price move, the price movement that follows will almost always be slower
(covering less distance or covering it in a shorter amount of time), even though the trend
may be still be in effect.
"False positive" divergence also often occurs when the price moves sideways, such as in a
range or triangle pattern following a trend. As discussed previously, a slowdown (sideways
movement or slow trending movement) in the price will cause the MACD to pull away from
its prior extremes and gravitate toward the zero line.
The MACD gravitates toward the zero line when the price is moving sideways because the
distance between the 26-period moving average and the 12-period moving average – what
the MACD is measuring – narrows. The moving averages (shown in Figure 4) have a much
harder time moving away from each other when the price is moving sideways. Signals the
MACD may provide while this is occurring are degraded, because moving averages – what the
indicator is based on – do not function well in choppy or sideways markets. (Moving
averages tend to work better in trends.)
T weekly chart showing MACD during price range
Figure 4: AT&T Inc. Weekly Chart Showing MACD Moving Toward Zero During Sideways Price
Movement
Since the MACD will almost always gravitate toward zero and likely away from prior extreme
MACD highs or lows, when the price moves sideways, the MACD will almost always show
divergence. Usually, these signals will be of little use because the MACD is just fluttering
around the zero line as the moving averages whip back and forth.
Having discussed some of the potential problems with the MACD, and what to watch for,
here are some ways to improve on MACD divergence using price action analysis as well.
Always Utilize Price Action With Divergence

Price is the ultimate indicator, with momentum indicators simply manipulating price data.
Use price action to aid decision making when using the MACD.
Here are some basic guidelines for doing so:
Expect to see divergence on the MACD when the price movement slows (relative to prior
price waves) or moves sideways. This isn't necessarily an indication of a reversal.
If divergence is present, don't exit a current trade only because of the divergence. For
example, if a stock is in an uptrend, don't exit the long trade simply because divergence is
present. As shown, divergence isn't a good timing indicator and may not result in a
reversal at all.
If looking to enter a trade based on divergence, wait for the price to break the current
trend, confirming the divergence, before acting. For example, if the trend is up but there
is bearish divergence, only go short once the price has broken out of the uptrend and is
moving in a downtrend. In an uptrend, the price must make lower swing highs and lower
swing lows to indicate a new downtrend. For a downtrend to reverse, the price must
make higher swing highs and higher swing lows.
Trust price action more than divergence. If the price breaks out of a prior trend, heed the
warning even if divergence wasn't present at the time of the reversal.
Even with these guidelines, divergence may provide beneficial insight on some trades, but
not others. It's a tool that may aid trading but is not perfect. Understanding the weaknesses,
and helping to compensate by also analyzing price action, is required.
The Bottom Line

Using indicators or divergence isn't a bad thing. Divergence shows the price is losing
momentum relative to prior price swings, but that doesn't necessarily indicate a price
reversal. Divergence also doesn't need to be present for the trend to reverse. Divergence
almost always occurs when the price makes a sharp move in the trending direction and then
moves sideways or continues to trend but at a slower pace. A sharp move followed by a
consolidation is often a sign of trend strength, not a reversal as MACD divergence would
suggest.
When using divergence, understand what causes it so that you can avoid some of the
problems with indicator divergence. Analyze price action as well; slowdowns in a trend are
visible without the use of the indicator, as are price reversals. If using divergence, test its
validity for aiding your entry and exit points over a several-month period to assess whether
divergence improves your performance or not.
Compete Risk Free with $100,000 in Virtual Cash

Put your trading skills to the test with our FREE Stock Simulator. Compete with thousands of
Investopedia traders and trade your way to the top! Submit trades in a virtual environment
before you start risking your own money. Practice trading strategies so that when you're
ready to enter the real market, you've had the practice you need. Try our Stock Simulator
today >>
Compare Accounts
Advertiser Disclosure
TradeStation
Low Trade Commissions with the Tools You Need to Manage Your Retirement Savings.
Related Articles
TECHNICAL ANALYSIS BASIC EDUCATION
What are the best technical indicators to complement
LEARN MORE
the moving average convergence divergence (MACD)?

Trading the MACD divergence

ADX: The Trend Strength Indicator

Introduction to Technical Analysis Price Patterns

MACD and Stochastic: A Double-Cross Strategy
Overbought or Oversold? Use the Relative Strength

Index to Find Out
Partner Links
Sign up for our daily newsletters
Trade like a top hedge fund manager using

technical analysis and double your wealth...
Learn to trade stocks by investing $100,000

virtual dollars...
Related Terms
Moving Average Convergence Divergence – MACD Definition
Moving Average Convergence Divergence (MACD) is defined as a trend-following momentum indicator
that shows the relationship between two moving averages of a security's price. more
Uptrend Definition
Uptrend is a term used to describe an overall upward trajectory in price. Many traders opt to trade
during uptrends with specific trending strategies. more
Piercing Pattern Definition

The piercing pattern is a two-day candle pattern that implies a potential reversal from a downward
trend to an upward trend. more
Swing High Definition and Tactics

Swing high is a technical analysis term that refers to price or indicator peak. Swing highs are analyzed
to show trend direction and strength. more
Exponential Moving Average (EMA)

An exponential moving average (EMA) is a type of moving average that places a greater weight and
significance on the most recent data points. more
Swing Low Definition

Swing low is a term used in technical analysis that refers to the troughs reached by a security's price
or an indicator. more
TRUSTe
About Us Advertise
Editorial Policy Contact Us
Privacy Policy Dictionary
California Privacy Notice News
Terms of Use Careers
Investopedia is part of the Dotdash publishing family.

Why MACD Divergence Can Be An Unreliable Signal

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Why MACD Divergence Can Be An Unreliable Signal

Uploaded by

Copyright:

Available Formats

5/1/2020 Why MACD Divergence Can Be an Unreliable Signal

TECHNICAL ANALYSIS TECHNICAL ANALYSIS BASIC EDUCATION

Why MACD Divergence Can Be an Unreliable

By CORY MITCHELL | Updated Dec 4, 2019

What Is Indicator Divergence?

SPY weekly chart uptrend with MACD divergence

Figure 1: SPDR S&P 500 ETF Weekly Chart Showing MACD Divergence During Uptrend

Indicator divergence is meant to show that momentum is waning during a trend and is

GLD weekly chart downtrend with MACD divergence

Figure 2: SPDR Gold Trust Weekly Chart Showing MACD Divergence During Downtrend

Common Problems With MACD Divergence

AAPL daily chart with false positive divergence

Figure 3: Apple Inc. Daily Chart Showing 'False Positive' Divergence

T weekly chart showing MACD during price range

Always Utilize Price Action With Divergence

Here are some basic guidelines for doing so:

The Bottom Line

Compete Risk Free with $100,000 in Virtual Cash

TECHNICAL ANALYSIS BASIC EDUCATION

TECHNICAL ANALYSIS BASIC EDUCATION

TECHNICAL ANALYSIS BASIC EDUCATION

TECHNICAL ANALYSIS BASIC EDUCATION

TECHNICAL ANALYSIS BASIC EDUCATION

Overbought or Oversold? Use the Relative Strength

Sign up for our daily newsletters

Trade like a top hedge fund manager using

Learn to trade stocks by investing $100,000

Piercing Pattern Definition

Swing High Definition and Tactics

Exponential Moving Average (EMA)

Swing Low Definition

Editorial Policy Contact Us

Privacy Policy Dictionary

California Privacy Notice News

Terms of Use Careers

Investopedia is part of the Dotdash publishing family.

You might also like