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Moving Average Convergence/Divergence ("MACD") Indicator – Pronounced "Mac Dee"

MACD is an oscillator that uses two moving averages that continually converge with and diverge from each other. When the trends are analyzed, they are used to time trading decisions for both individual stocks and the market. The faster trendline tracks the difference between the 12 day and 26 day exponential moving average ("EMA"). The second slower signal-line tracks a 9-day EMA of the faster (12 day – 26 day) EMA trendline. The slower signal-line is also referred to as the trigger line. The main objectives of the MACD oscillator are:

  • To identify and signal trend reversals, by generating buy and sell signals as the trendlines cross over each other.
  • To pinpoint overbought and oversold stocks, i.e.: stocks that are unusually high and may decline, and stocks that are usually low and might go up.
  • To confirm price and momentum trends.

Below is a diagram of the MACD oscillator, using Imperial Chemical Industries as an example. ICI is a global chemical company that successfully re-created itself by selling off its low margin, highly cyclical, commodity petro-chemical businesses and by purchasing less cyclical, higher margin specialty products.

Reproduced with permission of Yahoo! Inc. ă 2004 by Yahoo! Inc.
YAHOO! and the YAHOO! logo are trademarks of Yahoo! Inc.

The trendline oscillates around a zero horizontal centerline. When the MACD trendlines go above the zero point, they indicate an upward or buy trend. When the MACD trendlines fall below zero, they indicate a downward or sell sign.

The crossovers between the two moving averages generate buy and sell signals. When the faster MACD line crosses over and goes above the slower signal line, it indicates a buy signal. Conversely, when the faster MACD line crosses below the slower moving average line, it indicates a sell signal. When the trendlines cross each other, they signal a reversal or end to the current trend and the start of a new trend.

A divergence from the MACD trendline creates new trading signals. For instance, when the price of a stock diverges from the MACD trendlines, it’s a sign of the end of the current trend.

Additionally, when the faster moving average trendline diverges in an upward direction from its slower signal line, it indicates that the stock may be overvalued, overextended, overbought and that it may retrench to more realistic or normal levels. Conversely, if the opposite occurs, and the MACD trendline diverges in a downward direction from the trigger line, it can indicate that a stock has been oversold. Additionally, always keep abreast of company news when making decisions. Divergences occur for a reason; try to find out what caused them.

When the faster MACD trendline is greater than the slower MACD signal trendline, it indicates that the stock has positive momentum. Conversely, when the faster MACD line is less than the slower signal line, it indicates a declining momentum.

During rising markets, the faster moving average trend will rise quicker than the slower moving average. The reverse will happen in a declining market; the faster moving average trend will fall more quickly than the slower MA.

By using two moving averages, the MACD oscillator often can identify stock highs and lows, as well as signal changes in the direction of stock prices. Identifying the direction of price movements early on is always valuable information for investors.

Click below for more information on oscillators:
Rate of Change
Relative Strength Index
Price Oscillator
Stochastic
Money Flow Index
Williams %R
Volume + Moving Average

 

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