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 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 the recent action in Microsoft Corp. (NASDAQ: MSFT).
Since all technical indicators do not work all the time, one of the
considerations in making a trade should be managing risk. If I can find a
low risk trade that has good Risk vs. Reward characteristics, I will take a
second look at the trade.
Midday on June 13, 2000, MSFT gave a MACD Buy signal at 67 �.
MSFT rose over the next couple of days, however late Friday, MSFT flashed a
MACD Sell signal.
The range for MSFT was very small on Friday, usually indicating that a
volatile move may be ahead.
Since I have a MACD Sell signal, I would Sell Short MSFT of any unchanged or
down opening on Monday.
I would use a tight stop at 73 � which is about a 1 point risk. If the
trade works out, the reward can be much greater than the small risk on the
trade.
As always, if MSFT gaps up, do not take the trade.
