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MACD-Moving Average Convergence/Divergence
The MACD is an attempt to remove the lagging nature of moving averages to give the trader a foot up in trading. Of all the indicators available, this is one I find a lot of traders using. It’s easy to use but most traders get snookered into trying to find just the right settings and invariable end up either over trading or under trading. The indicator was developed by Gerald Appel to change the basic lagging nature of moving averages in into a momentum indicator.
Let’s talk about the parts of the indicator. The first is the smoothed MACD line. This line is produce by taking the difference between two exponential moving averages. The two most common ema’s used are the 12 and 26 for this line.
The second line is 9 period moving average of the MACD line. This is usually placed right alongside the MACD line and used as a “trigger” line. The third part of the indicator is the histogram. The histogram simply measures the difference between the trigger line and the MACD line, above or below zero. Some time the histogram is a measure of the difference between the zero line and the trigger line or the MACD line.
In the above example, a 12 period ema and a 26 period ema are drawn in the price channel. The MACD is drawn below the price channel and shows both MACD line in black and the trigger line in green. One of the benefits of using this indicator is the momentum predictive nature of the MACD. At line A, you see that the MACD has crossed before price really sets in to sideways action.
At line C the MACD crosses before a new retracement begins and it again does it at line D before price heads back to the top side. One of the draw backs to its predictive nature is that it will signal a new trend without the trend actually appearing. As it did al line B and at line A.
You will notice that even though the MACD is charted around a 0 line, there will be no top or bottom to the indicator. It could theoretically keep going higher and higher as well as lower and lower. So how do you use all of this?
MACD is a great momentum indicator and measures the markets strength in a given direction. One application is to look for possible reversal points that indicate a new trend is approaching. In the following example using the same cahrts above, a great example of this is developing.
As price increases under line A, the MACD is actually falling along line B. This is known as divergence. The same type of action continues as price is able to readh back to highs along line C but the MACD continues to fall along line D. As this continue to unfold, the pair falls.
A Bullish Centerline Crossover occurs when MACD moves above the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive, or from bearish to bullish. After a Positive Divergence and Bullish Centerline Crossover, the Bullish Centerline Crossover can act as a confirmation signal. Of the three signals, moving average crossover are probably the second most common signals.
Another use of the MACD is to watch for centerline crossovers. In this example, though it was a little late, the centerline crossover preceded a longer move higher.
The best way to get the most out of the MACD is to use a combination of support and resistance with crossovers and divergence. Here is an example using a combination of the items listed above. A short term resistance line had formed over the last few months at line B, but in the last few weeks, divergence formed between price action and the MACD histogram. When price finally broke the resistance at B, it was folled up closely by a bullish centerline break at C. A long position makes sense until price break the support line along line D and the MACD makes bearish cross down. By using all of this a more complete accurate picture is formed.
Using MACD histogram to initiate a setup is also an acceptable form of using the MACD. In this example, the hist. makes a new lower high, and is followed by a negative crossover. The other significant happening is that on two occasions the MACD itself was unable to get above the 0 line.
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Independent Study