Moving Average Convergence-Divergence - The Trading signal
By Trader Home
Moving Average convergence/Divergence (MACD) was developed by Gerald Appel, it is one of the simplest and most reliable trend-following indicator. It shows the difference between a fast and slow exponential moving average of the closing price, the result are then plot to forms a line that oscillates above and below zero, without any upper or lower limits.
The fast line called the MACD line and is the difference between two smoothed exponential moving averages of closing prices (usually 12 and 26-days). The slower line called the signal line and is usually a 9-days smoothed exponential moving average of the MACD line.
MACD Formula
The following are the steps to calculate MACD
1. Calculate the 12-days EMA of closing price
2. Calculate the 26-days EMA of closing price
3. MACD = 12-days EMA - 26-days EMA
4. Signal Line = 9-days EMA of MACD
Formula for EMA
EMA = (SC X (CP - PE)) + PE
SC = Smoothing Constant (Number of days)
CP = Current Price
PE = Previous EMA
* A SMA is used for first period's calculation
Trading signals
MACD crossing Signal line
There are 2 types of cross over between MACD and Signal line.
MACD falls below Signal line
It is a bearish sign which indicates as a sell signal and the price of the underlying stock is likely to experience downward momentum.
MACD rises above Signal line
It is a bullish signal which indicates as a buy signal and the price of the underlying stock is likely to experience upward momentum.
MACD line crossing Zero MACD can cross above or below the Zero line. A crossing of the MACD line above Zero interpreted as a bullish sign and the stock likely to go upward. On the other hand, a crossing of MACD line below the Zero line interpreted as a bearish sign and the stock is likely to go downward.
The Zero line is often acts as an support or resistance for MACD.
Overbought / Oversold
MACD values can also fluctuate above and below the Zero line. When it rises dramatically and is too far above the Zero line, it indicate as an overbought condition. When MACD falls dramatically and is too far below from the Zero line, it indicates as an oversold condition.
When either one of the condition above occurs, the shorter moving average pulls away from the longer term moving average. The stock is extremely overbought or oversold under these conditions and will soon return to normal levels.
Divergences
Divergences appear between the trend of the MACD lines and the stock price. There are two types of divergences: Bearish divergence and Bullish divergence.
Bullish divergence occurs when MACD line is below the Zero line and start to show strength while prices continue to move downward. This is always a signal that underlying stock has reached bottom.
Bearish divergence occurs when MACD line is above the Zero line and start to weaken while prices continue to raise or trend higher. This is a warning where the underlying stock has reached the Top.
Both of these divergences are most significant when they occur at relatively high or low levels.
In MACD-Trader blog, we scan for more than 6000+ stock symbols in the NYSE and NASDQA for MACD line crossovers. You can visit us at http://macd-trader.blogspot.com.
For other tips and advice on how to perform you own market analysis, please visit DIY Traders page at http://www.diytraders.com
We strongly recommend you to combine MACD with other indicators as a confirmation of the trend.
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