What is MACD?

The popular “MacD”, Moving Average Convergence Divergence (MACD) is a trending indicator, telling us whether a stock is in an uptrend or a downtrend. Developed by Gerald Appel in the 60s, the MACD Oscillator is composed of two lines: the MACD line, which is the difference between two exponential moving averages (EMAs) and a signal line, which is an EMA of the MACD line itself. The signal line is plotted on top of the MACD to show buy/sell alerts. Generally, MACD uses a 26-day and 12-day EMA, based on the daily close, and a 9-day EMA for the signal line.

There are two techniques commonly used to interpret the MACD:

1. Crossovers - When the MACD drops below the signal line, it is a bearish signal indicating that it may be time to sell or go short. Conversely, when the MACD goes above the signal line, the indicator gives a bullish signal, suggesting that it may be a good time to buy.

2. Divergence - When the stock price moves in opposite direction to the MACD, it signals the current trend may come to an end. Negative divergence is that when stock price creates higher high but the MACD fails to reach new high, be on the alert that the recent price uptrend move may reverse. Positive divergence is that when stock price hits lower low but the MACD fails to create lower low, it signals that recent downward movement of stock price may end and stock price may resume upward movement again.

MACD Crossover Signals

The above is a candlestick chart of a stock with MACD crossover signals at the bottom. You can see that for this stock the MACD signals have been quite accurate, giving 5 crossover signals between April and August. I would have no complains with this indicator.

First signal
In mid April, the MACD line cut below the signal line triggering a sell signal and the stock price corrected for a few days.

Second signal
Then in end April, the MACD cut back up the signal line giving a buy signal and we can see the stock price staged a nice rally.

Third signal
At the end of May the MACD line cut below again. The stock price corrected briefly. The MACD line then stayed below the signal line for one month with the stock price moving side-way.

Fourth signal
Early July the MACD line cut above signal line again giving a buy signal and a nice rally.

Fifth signal
End July MACD line cut below signal line giving sell signal.

MACD Divergence Signals
The above is a candlestick chart of a stock with MACD divergence signals at the bottom. MACD divergence signals do not happen very often BUT the accuracy is quite high. You can see that for this stock the MACD divergence signals occurred twice and both signals have been quite accurate, giving 2 MACD divergence signals in February and March.

First signal :
At the end of February, when stock price rallied to a Higher High, we can see that MACD rebounded BUT only to a Lower High, this is a sign that the upward momentum may be losing steam. After the MACD divergence, we can also see that there is a bearish engulfing candlestick chart pattern (a negative reversal signal also) raising the probability that the stock is likely to correct soon. And so it did dropping over the next few days.

Second signal :
In early March, we can see that the stock start to stabilize and has not created new lows. In fact it created a Higher Low in the middle of March while the MACD line created a Lower Low. This divergence signal indicated that the downward trend may end soon. And so it did, moving steadily upward again. This was further confirmed by the MACD line cutting above the signal line.

Weakness of MACD
Many traders will tell you that the most common problem of using MACD is that it is a lagging indicator since it is based on averages of historical prices. However, it remains one of the most favored tools by many traders and should be used in combination with other tools. Also, MACD signals although lagging, still give earlier signal than the basic moving average crossover signals.

Note
When using any indicator, do not just rely on the signal from one indicator, it is always good practice to combine the signals with other indicators to increase the probabilities.

Personal tips
Past pattern will also give you an insight into potential future behaviour. If previously the stock reacted in a specific way to the past signals, the odds of it reacting in the same manner in future is likely to be higher.

Article by Rooneyhttp://www.Mojostock.com Article Source: http://EzineArticles.com/?expert=Rooney_Yong



Example Chart of MACD Crossover:

MACD is crossing above at my red vertical line indicators.





Price is what you pay. Value is what you get. - Warren Buffet