Moving Average Convergence/Divergence (MACD)
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).
On October 18, the chart of MSFT on a short term basis was looking poor.
The stock dropped from the 95 area on October 11 and was moving straight down.
Late in the day on October 11, MSFT gave a MACD Buy signal at 87 7/8. After
a little more base forming on October 12, MSFT moved up sharply in the next
few days.
However, on Friday, October 22, MACD signaled a Sell late in the day.
MACD measures momentum changes and it is not surprising to see this signal
as MSFT upward movement has slowed.
Although MSFT has not started down, the MACD is saying that MSFT has run
out of short term momentum.
An aggressive trader may want to exit MSFT on any weakness from Friday's
close of 92 11/16.
A short on any weakness to the 92 area can be established with a stop at 93
�.
Please note that the daily MACD is on a Buy and stops are always critical
in any trading decisions. We use 60 minute bars here, and on a 60 minute
bar, MSFT should be out or short for a trader.
