MACD
The Moving Average Convergence/Divergence indicator (MACD) is calculated by subtracting the value of a 26-period exponential moving average from a 12-period exponential moving average (EMA). A 9-period dotted exponential moving average (the "signal line") of the difference between the 26 and 12 period EMA is used as the signal line.
The basic MACD trading rule is to sell when the MACD falls below its 9 day signal line and to buy when the MACD rises above the 9 day signal line. Traders sometimes vary the calculation period of the signal line and may use different moving average lengths in calculating the MACD dependent on the security and trading strategy.
As you can see from the graph of the Nasdaq and the MACD above, the signals generated by the MACD are trend following, occurring after the market has made movement in a new direction. For this reason the MACD is used more as a conformational tool of the trend and can be used in trading decisions when combined with other indicators and platforms for decision and strategies.
Crossover signals
The signal line, which is a 9 day moving average of the difference between two other moving averages, crosses over the MACD and creates a signal. The caution occurs when the market is in a sideways trending motion, where multiple crossovers can occur in a short period of time. This is principally the origin of the need to use other conformational tools when developing trading strategies that incorporate the MACD.
On the Graph MACD signals are shown on a graph of the S&P400 Midcap Index. Notice that the market is trending largely sideways during the period. MACD signals are crossovers and are indicated with numbers. An ellipse has been drawn over the price bars to indicate the days when the signals appeared. Number 1 is a sell signal that is given at the bottom of short trend. The blue horizontal trendline is a support area generated historically that is another technical tool that can be used to help identify the importance of other signals like the MACD. Numbers 1,3,4, and 5 are late signals that preformed badly over the period. Signal 2 and 6 had potential for profitability.
Divergences are another use for the MACD. When there is a divergence between the indicator and the price action of the security being analyzed, there is a possibility of a trend reversal. A divergence between the troughs of indicator and price can indication that rising markets will commence near term. At the number 1, the rise in late May was preceded by a divergence of troughs. A divergence of peaks can be an indication that markets have a possibility of falling near term. The number 2 on the graph precedes a fall in the markets in late July. The divergence between the peaks at the number 3 on the graph precedes falling markets as September got under way in the year 2000.. Principally a divergence warns of a potential for a reversal of price trend. Conformational evidence in price and other market data and tools should accompany trading decisions.
To the right technical studies are examined in more detail to provide a sense of conformational evidence for traders of the critical day. Click on any of the terms to take a closer look at a technical discussion on that topic. All formations, patterns, indicators and technical tools fail at various times and so should only be used to build a body of evidence in forming a trading decision rather than being solely relied upon. There are a number of valuable studies that lead to intuitive understandings about price and volume but a strong compliment to technical analysis is an understanding of the trends and changes in the fundamentals and economic activity that ultimately lead valuation levels in the markets.
Walk through a critical day
| The graphs show a price plot of the Dow Jones Industrials from Sept 28/00 to early November. The First graph ends on November 3/00, two days before an upcoming critical day on November 7/00. Our members looking at the market are expecting a trend reversal to occur due to the high rate of success in our research. Ideally a member will be using their own skills to judge the supply and demand changes, using technical and fundamental indications to confirm suspicions of a reversal, and trade accordingly. |
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| On the second graph we see that the price action on November 6 was a bullish day, reversing the short trend so that the short trend leading into the critical day is now up. A critical day is an expectation of a reversal of the short trend that immediately precedes the critical day. In the case of the November 7 signal, given to members 3 days before, is an indication that the upward moving trend, recognized at the close of November 6 is expected to reverse direction. |
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| On the third graph we can see that November 7 was a low volatility after a large gain on November 6 of about 160 points for the Dow Jones Industrials. The subsequent move over the three days following the November 7 signal saw the Dow Jones Industrials fall 376 points. The next day, November 13, the Dow Jones Industrials lost an additional 83 points with intra-day low a full 609 point loss since the open on the critical day. |
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| A closer view of the most recent signals. You can see the short trend immediately prior to a successful critical day, reverses coming away from the critical day. Often a failed critical day will indicate a stronger bias in the market for continuation of the trend that was in place prior to the critical day. A failed signal can therefore provide as much information and opportunity as a successful one. Take a look at tech studies to develop a sense of trend reversals and use. |
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