103-13 Indicators – MACD

Moving Average Convergence Divergence MACD

Gerald Appel developed MACD as a means of quickly showing the Moving Averages of stock in a way that could explain the strength of the difference of the Moving Averages.

For example, if the 10 & 20 day moving averages for a stock move away from each other as the stock is going up, this means the stock is gaining strength.

MACD is based on five configurable parameters

  • Short = the shorter Moving average e.g., 10
  • Long = the longer moving average e.g., 20 or 30, etc
  • Period = the Moving average of the difference between the Short and Long above.
  • SMA or EMA as the calculation for the moving averages
  • Plot as histogram

Use a short MACD configuration for shorter-term trading 5-35-5, or more extended configurations for longer-term trading 12-26-9 is popular, also 10-30-5.

Experiment and also view charts on different timeframes to test if the indicator works during different time periods.

Next, we will use a practical example to see the usage of MACD in real stock.

Please beware, sometimes MACD does not tell you anything about a stock, but in many cases it does.  As always, if the indicators show you nothing, there is probably nothing to be told to move on and look for other stocks.

Take a look at the Netflix (NFLX) Learning Chart below. Here we have a MACD configured of 10, 30, 5 Simple, and this is a 2 Day (per bar) Chart.

103-13 Indicators - MACD - 1

Price Growth: Stock price is in growth mode, almost doubling in the first quarter of 2008.

Negative Divergence: The trick with MACD is to look at the trend; it is a powerful indicator when you compare the direction of the MACD Mountains with the Price Movement.

Notes on the chart

  1. Price is increasing
  2. At point 2, we see that although the price doubled in 2008 (point 1), we saw the MACD make lower lows “negative divergence.” We see here a change in the MACD from positive to negative and the towering mountain (below the Zero Line) forms. MACD is an oscillating indicator and, as such, is always tied to the Zero line in the middle.
  3. Price declining: here we see a sharp decline in price for the rest of 2008 until November. Using a trend line to show this helps us visualize the direction easier.
  4. Positive Divergence: At the same time, the price is declining; we see a longer-term Positive Divergence occurring from June to December. This essentially means that the “Gas in the tank” of the sellers is slowly reducing.  However, we should not have waited until December to buy the stock that would have been way too late. Instead, we would look to Point 5.
  5. Buy Signal: MACD broke through the line of resistance: here we see the MACD breaking sharply past its previous high. I plotted a Trend Line in Orange to show this clearly.

If you had used MACD as your BUY SIGNAL, you would have netted 56% in 4 months.

Summary

  • MACD is an oscillating indicator
  • Its real strength lies in its ability to diverge with price, showing that the trend may be changing or “How much fuel in the tank.”
  • Use short MACD configuration for shorter-term trading 5-35-5, or more extended configurations for longer-term trading 12-26-9 is popular, also 10-30-5. Experiment, and even view charts on different time frames to test if the indicator is accurate from different angles.

Further Reading.

5 Easy Steps to Use the MACD Stock Chart Indicator

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