MACD – an acronym for Moving Average Convergence Divergence – is a largely popular tool in technical analysis. Its ability to recognize quickly and easily the trends allow traders to use it to determine momentum, direction, and potential reversal in stock trading.
While it is commonly used to confirm stock trades of other strategies, it also offers its own effectual trade signals.
What is MACD?
Developed in the 1970s by Gerald Appel, Moving Average Convergence Divergence is identified as moving averages, which indicate a new trend. It entails of three components: a histogram and two exponential moving averages (EMA) – the MACD line and the signal line.
Essentially, the Moving Average Convergence Divergence line is the difference between the 12-period EMA (faster one) value and the 26-period EMA (slower one) of the asset price. This gives the short to medium-term price action trends. A negative Moving Average Convergence Divergence value indicates a downward price trend while a positive one indicates an upward price trend.
The signal line is the MACD 9-period EMA while the histogram is the difference between the signal line and Moving Average Convergence Divergence line. Thus, the histogram can help to evaluate the velocity of downward or upward movement.
Strategies for Trading with the MACD indicator
You can use three primary ways to trade with Moving Average Convergence Divergence indicator efficiently. Combing the pros of all the three will help you to eliminate some losing MACD trade signals.
A zero line crossover occurs when the series moves over the horizontal zero axis. When the Moving Average Convergence Divergence series crosses over from positive to negative, that can be interpreted as a new downtrend emerging signal while a negative to positive run could be taken as a new uptrend emerging signal. The strategy is to buy or hold long trades when the MACD runs above the zero line and sell or take short trades when the MACD line crosses below the zero line.
The 9-day EMA (signal line) crossover is the most common Moving Average Convergence Divergence signal since it is easy to trail and spot MACD turns. When the MACD line runs upward over the average line, this can indicate a bullish signal while a crossover downward the average line shows a bearish signal. More so, it can be tracked easily by the MACD histogram. A bearish signal occurs if the histogram moves from positive to negative and a bullish signal occur if the histogram goes from negative to positive.
Usually, when the price makes new highs and the Moving Average Convergence Divergence does not, that can be considered as the bearish divergence. That indicates that the momentum has slowed and a reversal could be imminent. Bullish divergence, on the other hand, occurs when the price is making new lows and the MACD is not. This illustrates that the selling pressure has slowed and a reversal higher could be forthcoming.
Scrutinizing the different components of each strategy ensures you employ the MACD indicator more meritoriously. Using trend and price analysis can help to determine which signals to take, for instance, only taking buy signals if there is a long-term uptrend. Moreover, the clear transaction signals reduce the subjectivity and allow traders to trade stocks in the right momentum.