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.
I will also use MACD combined with the breaking of support. Support can be
defined differently depending on the strategy. I like using the lowest low
and highest high of the last 20 bars depending on my time frame or a change
in moving average direction.
This week I have been focusing on the MACD indicator and exit strategies.
An exit is even more important than the entry as it is how we take our
profits, or limit our losses. I am always more focused on the exit. I want
to know where my stop is on losing trades and when to get out of a
profitable trade. The MACD indicator is helpful for these points.
Let's look at Korea Thrunet, (NASDAQ: KOREA).
KOREA is a recent IPO and after a few down days, the stock found a bottom
and started moving up.
On November 24, KOREA flashed a Buy signal using MACD at 11:00 AM EST.
MACD continued to rise until late in the day on November 30 when the stock
lost momentum.
Early today, December 1, 1999, KOREA flashed a MACD Sell signal.
I would exit a stock with this pattern here.
Since this is a new issue, it can not be shorted for 30 days.
Use this pattern to help you with exits in your stocks. When the MACD turns
around, there are many profitable signals from these too.
