Thursday, September 18, 2008

Moving Average Convergence Divergence (MACD)


MACD is a lag momentum indicator that shows the relationship between moving averages of prices. It is the difference between a 26-day and a 12-day exponential moving average. On top of this, a 9-day exponential moving average is plotted. This 9-day EMA is called the signal or the trigger line and is used to spot buying or selling opportunities.

How is MACD Used ?

MACD is best used in markets that are prone to wide swings in a trading sense. The three best methods of using MACD effectively are:

Crossovers

The primary use of this indicator for trading is to buy when the MACD rises above the signal line and to sell when the MACD falls below its signal line. Another use is to buy when MACD goes above zero and sell when MACD goes below zero.

Overbought/Oversold

MACD can be put to use as an overbought/oversold indicator too. When the shorter MA pulls away too much from the longer MA, it means that the security/Index is over-extended and that it is likely to return to realistic levels soon. This of course, depends on the nature of the movement of the security or Index that is being analyzed.

Divergences

The divergence of MACD from the price may indicate that an end to the current trend is at hand. A bearish divergence happens when the MACD is making new lows but the prices do not. Similarly, a bullish divergence occurs when MACD is making new highs but the prices do not make new highs. Divergences are more important when they occur at the overbought/oversold levels.

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