Moving Averages and Moving Average Crossovers
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 period) 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.
Moving averages are used to smooth prices, dampening the distractions of
short price movement so that the underlying trend is clearer. Moving
averages always lag the market and, therefore, will never buy market
bottoms or sell market tops. Like any other trend-following system, the
moving average crossover will perform best when markets are trending
because it automatically places the trader on the right side of every
extended move. When markets are moving sideways, however, the lack of
extended moves will cause losses.
The MACD "Moving Average Convergence/Divergence" 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 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.
Let's look at Applied Materials, AMAT.
After moving down over the past couple of weeks, AMAT started moving up the
morning of August 23. You can see from the chart below the action of AMAT
and how MACD ran out of steam and gave a Sell signal. Late this afternoon,
AMAT also signaled a Sell using the moving average crossover system.
If these indicators are going to be accurate in this new signal, AMAT
should open unchanged or lower in the morning and move down.
A close stop can be placed in a trade like this.
I would exit longs in AMAT.
I would Sell AMAT short at the open and place a stop at 69 �.
