Moving Average Convergence Divergence – Is it Important?
MACD or Moving Average Convergence Divergence is a great way assess a stock price direction. LEARN how to use this powerful indicator.
On the topic of MACD, I decided to reduce the amount of noise on the topic to the essential need to know information. I encourage you if you have a day to spare, to do further reading on the topic, however, it can be a little hard going and is good if you suffer insomnia.
Is MACD is an important indicator.
MACD was developed by Gerald Appel as a means of easily showing the Moving Averages of a stock in a way that could show 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 3 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 of the Short and Long above.
Use short MACD configuration for shorter term trading 5-35-5, or longer 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 is true from different angles.
This could go on and on, however, I will suggest now we move to a more practical use of MACD viewing it in real life on a real stock.
Please be aware, sometimes MACD does not tell you anything about a stock, but in many cases it does. As always, if the indicators tell you nothing there is probably nothing to be told move on and look for other stocks.
MACD In Action – Detailed Example
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
5 Point Guide to the MACD Chart
Point 1 – Price Growing
The Stock price is in growth mode almost doubling in the first quarter 2008.
Point 2 – 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.
Point 2 illustrates, that although the price doubled in 2008 we saw the MACD make lower lows “negative divergence”.
We see here a change in the MACD from positive to negative and the large mountain (below the Zero Line) forms. MACD is an oscillating indicator and as such is always tied to the Zero line in the middle.
Point 3 – Price declining
Here we see a strong decline in price for the rest of 2008 until November. Using a trend line to show this helps us visualize the direction easier.
Point 4 – Positive Divergence
At the same time the price is declining we actually 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.
Point 5 – Buy Signal
MACD broke through the line of resistance: here we see the MACD breaking strongly 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.
Please do not think I searched through hundreds of charts to find a good example to demonstrate here. I did not; this was a stock in my watch list, and indeed bought based on this lesson. As you can see the dates are up to end of January 2009 in this historical example.
What did we learn about MACD?
- 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 longer 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 is true from different angles.
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