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.
Over the past few days, we are seeing the same pattern in many stocks. They
are running out of steam and MACD and momentum are rolling over.
Let's look at E Trade Group, (NASDAQ: EGRP).
EGRP is another example of a stock that has bounced from the August 10 low,
but may now be running out of momentum.
This turn may not signal a new trend. It may just be a retracement of part
of the large gain from 22 to 31that EGRP has experienced in the last week
of trading.
At the August 10 low, EGRP was at 26 and has trended up to 31.
Volume peaked yesterday without any follow through on that volume.
Can this be a temporary top?
The MACD indicator is saying Yes!
Notice how the MACD indicator has signaled a Sell signal.
Any drop will also cause the moving averages to cross to a Sell signal.
On any lower opening in EGRP in the morning (August 20, 1999) I would exit
longs.
An aggressive trader may want to establish a Short position at this time.
I would place a stop and reverse at 28 �.
