Thread by @Prashantshah267

MACD -> Disparity: Thread

MACD is a popular indicator created by Gerald Appel. It calculates the difference between two moving averages. The MACD line is calculated by subtracting the longer-term average from the shorter-term average. The average line of MACD line is known as the signal line.

So,
MACD line = Short-term ave – Long-term ave
Signal line = Average line of MACD line

Short-term ave > Long-term ave = MACD > 0
Short-term ave < Long-term ave = MACD < 0

When the distance between the shorter term & the longer term average is increasing, & price is in an uptrend, it means that the shorter term trend is accelerating more than the longer term average. In other words, it means that the price is increasing rapidly.

When MACD is above the zero line and the distance between the average lines is increasing, it is a strong bullish trend. When the MACD line crosses the signal line downwards, it indicates that the distance has started shrinking.

The gap or distance between the averages can be a significant observation. When the gap between moving average lines increases a lot, it also indicates exhaustion. The price may correct, or consolidate, when the distance between the averages starts reducing.

Study past data and find the historical high of MACD line. It gives us idea about high historical distance level between two moving averages, and a possibility of mean reversion. Seek confirmation to plan the trade: MACD Signal line crossover, price patterns etc.

Chart showing MACD at historical highs followed by price / time correction. What if we keep short-term parameter as 1?

If short-term ave parameter is 1, it will be a proxy for the actual price. This way, the MACD line calculates the diff between the price & ave line. When the gap bw price & the moving ave line increases, it can revert to the mean.. either through a correction or a consolidation.

MACD on Renko chart. Short-term ave is 1 (price) & long-term is 40. There is no ‘time’ on this chart. When distance is at historical high, & if it reverts to the mean – price needs to correct. It may be a shallow correction but.. price correction, not time.

This concept of price and average line distance is also known as disparity. The concept of disparity index was introduced by Steve Nison in his book, Beyond Candlesticks. End of thread.