MACD "Moving Average Convergence/Divergence"
The MACD is a trend following momentum indicator that shows the
relationship between three moving averages of prices.
This method can be used for any time frame. It could be 5 minute bars, 15
minutes bars, 60 minute, or daily bars. Many traders will also trade in
multiple time frames using a longer time frame for trend, and the shorter
period for entry and exit.
The MACD is the difference between a 26-period and 12-period exponential
moving average. A 9 period exponential moving average, called the "signal"
(or "trigger") line is plotted on top of the MACD to show buy/sell
opportunities. On the charts below, the MACD line is the green colored
line, and the trailing, slower moving line is the signal line. Some
technical analysis programs will show the MACD as a histogram bar.
There are three popular ways to use the MACD: crossovers,
overbought/oversold conditions, and divergences.
The most common use is as a crossover method. Using this interpretation,
the trading rule is to sell when the MACD falls below its signal line.
Similarly, a buy signal occurs when the MACD rises above its signal line.
It is also popular to buy/sell when the MACD goes above/below zero.
Some traders will use MACD as an overbought and oversold indicator. When
using the indicator in this manner, when the shorter moving average pulls
away dramatically from the longer moving average (i.e., the MACD rises), it
is likely that the security price is overextending and will soon return to
more realistic levels. MACD overbought and oversold conditions vary from
security to security.
The other way some traders use MACD is to spot divergences from an
anticipated movement. Since there are no indicators or patterns that work
all the time, reactions against the anticipated move can signal a major
move. A bearish divergence occurs when the MACD is making new lows while
prices fail to reach new lows. A bullish divergence occurs when the MACD is
making new highs while prices fail to reach new highs. Both of these
divergences are most significant when they occur at relatively
overbought/oversold levels.
The moving average crossover method calculates two moving averages, each
based on a different number of periods of trading data. When the
shorter-term (fewer periods) average crosses above the longer-term average
from below, this is a buy signal. When the shorter-term average crosses
below the longer-term average from above, this is a sell signal.
Let's look at Home Depot, (NYSE: HD).
Many stocks have bounced from the August 10 low.
The question now is when will the stocks run out of momentum.
The MACD indicator can signal turns in momentum.
In early August, HD dropped from a support of 63.
The MACD indicator would have had you short during this downtrend.
On August 10, the MACD, momentum, and moving averages all reversed to a Buy
signal.
Now the MACD has turned negative again as momentum is slowing down.
I would exit longs in HD.
An aggressive trader may want to Short HD here.
I would place my stop at 65 �.
