The MACD or moving average convergence divergence is a powerful and useful tool developed by Gerald Appel. It is a staple on my charts and I use it frequently to help me trade stocks. First things first, this is not a infinite article about the MACD and how it is constructed. If you want to learn about the construction, I recommend you go and read Stockcharts.com's MACD page.
On this page, I will be discussing on how I use the MACD and how you can take advantage of this technical oscillator to make money in the stock market.
There are 4 components in the MACD which I find helpful:
I also use the most basic version which is the MACD (12,26,9). Best to stick with what is the most popular.
The chart above shows the price of BPL with the MACD indicator. The blue graph is the histogram. The black and red moving averages can give buy or sell signal when they crossover each other. When the moving averages crossover, the histogram also crossover 0 into positive or negative territory. Finally there is the trend indicator which tells us how strong the trend is.
The most basic way to use the MACD is to look for moving average crossover signals.
In the chart above, you can see the MACD giving a few reliable buy and sell signals. In October, the MACD gave a good buy signal. In late October, the sell signal proved to be a reliable one. Then in mid November, the MACD gave a great buy signal.
Not all buy or sell signals will work. As you can observe from the chart above, there are many bad signals as well which produces whipsaws. You will need to complement these signals with other technical analysis such as support and resistance, trend analysis and stage analysis.
MACD can be used as a trend indicator to determine how well the stock is trending. It gives you confidence to hold on to a stock.
In the chart above, Yahoo had a buy signal in early January. Notice the smooth railroad tracks between the two moving averages? The tracks pointed out to us that this stock will have a good trend. When the moving averages begin to close, it signal to us that the trend is ending or at least it will be moving sideways for awhile.
Whenever a stock moves in one direction, it will eventually slow down and change direction. That is the way with stocks. They do not go up or down forever. The MACD Histogram is very useful to tell us when momentum in one direction is slowing down.
In the chart above, you can see how NOV had a drop in late October. The Histogram formed a valley but it shortened. The moment one of the bars of the histogram shortens, this told us that the downward momentum is slowing down. Eventually you see more shorter bars which tell us the momentum is reversing to the upside. Look at how the stock rose from there.
The MACD is very useful to spot divergences. Price will either diverge from the MACD Histogram or the MACD's moving averages.
In the chart above, Pay Pal formed a double bottom pattern in December with a second bottom that is lower. However, the MACD formed a higher histogram which told us there was internal strength in the stock. This was a bullish divergence. The stock eventually rose higher.
The chart of R above shows bearish divergence at work. R was riding a bullish wave higher in November and December. However, the MACD Histogram and MACD moving averages were declining. This showed us that there was internal weakness in the stock. The stock eventually declined.
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