Gerald Appel developed the Moving Average Convergence Divergence indicator using three moving averages as a tool to approximate turning points in the market. The MACD is a popular trading tool despite the fact that it often gives false indications of turning points. It takes practice and judgment to use the indicator properly.
Things You'll Need
- Spreadsheet to calculate the MACD
Constructing the MACD
Compute two moving averages. Enter the last 26 days of closing prices in column one. Average the result in column two. For the next day drop the oldest date and add the newest. Compute the last 12 days of the moving average from column one and enter the result in column three. Subtract column two from column three. Enter the result in column 4. This is called the fast line of the MACD.
Take the result of the fast line and from it compute a nine day moving average. This is the trigger line. When the fast line and the trigger line converge a turning point is reached. Know that a turning point should confirm what the closing price action is already beginning to show--that a buy or sell signal is in place.
View the MACD as a histogram (see Resources for illustrations). The bars reflect closing prices. Use the zero line or center line to indicate whether either moving average is moving at a positive or negative rate. When the MACD rises above zero, the short-term average is above the long-term average, a signal of upward momentum. Use the center line as another indicator of price trend change.
Trade a security if there is divergence between the direction of the MACD and price. It is a sure sign (if the histogram is positive) that prices are preparing to fall. Wait, however until the histogram falls below the center line. Bullish signals occur when the divergence occurs when the histogram is negative.
Trade the MACD but realize it is a tool that is generally right but will give lagging signals of turning points. MACD gives signals three ways: when the histogram trades above or below the center line, when divergence occurs, and when the fast line and center line cross.
Tips & Warnings
- Never trade the MACD as a single indicator. Use a long term indicator such as a 50 day or 200 day moving average in order to reduce the number of whipsaws.
- Practice trade over a variety of market conditions before investing real money with the MACD.
- Photo Credit http://www.sxc.hu/profile/OmirOnia
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