Moving Average Convergence Divergence – Is it Important?
MACD or Moving Average Convergence Divergence is a great way to assess a stock price direction. LEARN how to use this powerful indicator. In this article, I provide the essential need to know information. I encourage you if you have a day to spare, to do further reading on the subject; however, it can be a little hard going and is useful if you suffer insomnia.
What is the MACD Indicator?
MACD was developed by Gerald Appel 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.
How to Calculate MACD?
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.
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 also view charts on different timeframes to test if the indicator is accurate 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 an actual 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 show you nothing, move on and look for other stocks.
How to Use the MACD Chart Indicator
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.
1. Price Growing
The stock price is in growth mode, almost doubling in the first quarter.
2. Looks for 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 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. The 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. Looks for 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.
5. See the 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.
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 the 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 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 is accurate from different angles.
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