Sharpening Your Trading Skills With MACD Indicator

The Moving Average Convergence Divergence (MACD) indicator has been one of the computer-generated technical indicators in recent years.

MACD, developed by Gerald Appel, is a trend follower and market momentum indicator (oscillator). MACD is the difference between fast exponential moving averages and slow exponential moving averages. The exponential moving average is a weighted moving average that usually gives greater weight to newer price actions.

The name "Moving Average Convergence Divergence" comes from the fact that exponential moving averages constantly converge towards or deviate from the slow exponential moving average. The third dotted exponential moving average of the MACD ("trigger" or signal line) is then plotted over the MACD.

Parameter:

Mov1: The time period for the first exponential moving average. The default value is usually 12, referring to 12 bars of whatever time period is plotted on the chart. (This is a fast moving average.)

Mov2: The time period for exponential moving averages is reduced. The default value is usually 26, referring to 26 bars. (This is a slow moving average.)

Trigger: The 9 bar period for signal channels represents an additional exponential moving average.

The MACD study can be interpreted as an analysis following other trends: A line that crosses another indicates either a buy or sell signal. When MACD crosses above the signal line, the upward trend may start, suggesting a purchase. Conversely, a cross below the signal line can indicate a downtrend and sell signal. Crossover signals are more reliable when applied to the weekly chart, although this indicator can be applied to the daily chart for short-term trading.

MACD can indicate overbought and oversold trends if analyzed as an oscillator that fluctuates above and below the zero line. The market is oversold when the two lines are below zero, and it is overbought when the two lines are above the zero line.

MACD can also help identify differences between indicators and price activity, which can indicate a trend reversal or a trend to lose momentum. Bearish divergence occurs when MACD makes new lows while prices fail to reach new lows. This can be an initial signal of a downward trend in the downward trend. A bullish divergence occurs when MACD makes new highs while prices fail to reach new highs. These two signals are most serious when they occur at a level that is relatively overbought/oversold. The weekly chart is more reliable than the daily analysis of divergence with the MACD indicator.

For more details about MACD, Appel has a printed book, entitled: "Moving Average Divergence-Divergence Trading Methods."

Like most other computer-generated technical indicators, MACD is a "secondary" indicator in my trading toolbox. This is not as important as my "primary" technical indicators, such as trendlines, chart slits, chart patterns, and fundamental analysis. I use MACD to help me confirm the signal that my main indicator might send. 

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