MACD can be pronounced as either “Mac-Dee” or “M-A-C-D.”
The MACD indicator is used to basically reveal changes in the strength, direction, momentum and duration of a trend in the stock market. The MACD is based on moving averages and is a “lagging indicator.” The MACD is also a trend-following momentum indicator. If the indicator has a zero center line; then values above the zero line are bullish, while those below the line are bearish.
The MACD is based on two moving averages such as, for example 10 and 30 days and the application is utilized when the short-term averages passes the mid-term moving average system and the market sector is generally moving in the direction of passing. The Center-Line crossover signals will be the best signals for confirming buy and sell signals.
The MACD should not be utilized for stocks that are not trading in a range or are trading unpredictably with an inconsistent or erratic price action. It is not useful for identifying overbought or oversold levels.
The volume of stock being bought or sold is very important in this analysis of the MACD, as it is used to confirm trends and chart patterns. If there is high volume stock trading any price movement is seen as a stronger and a more relevant move than with a move that is trading with a very low volume of stock.
What does the MACD tell us? It gives us prior notice before two EMAs cross. It can be used to recognize bullish (buy) and bearish (sell) signals.
What are the three types of MACD – Bullish (buy) Signals?
- Positive Divergence – the MACD begins to advance while the security itself remains in a downward trend.
- Bullish Moving Average Crossover the actual MACD moves above the trigger line.
- Bullish Centerline Crossover – moves above the trigger line or into positive territory.
When does a bullish centerline crossover occur? A bullish centerline crossover occurs when the MACD moves above the zero line and into positive territory.
What are the three types of MACD Bearish (sell) Signals?
- Negative Divergence – the MACD declines as security moves sideways or up.
- Bearish Moving Average Crossover – the actual MACD moves below the trigger line.
- Bearish Centerline Crossover – moves below the zero line or into negative territory.
Utilizing a combination of the three bearish signals above will provide a more reliable indicator of a negative price change in the equity.
What is a Negative Divergence?
A negative divergence forms when the security advances or moves sideways and MACD declines. The negative divergence in MACD can take the form of either a lower high or a straight decline. Negative divergences are probably the least common of the three signals, but are usually the most reliable and can warn of an impending peak.
What is a “Lagging Indicator?”
A lagging indicator is a measurable economic factor that changes only after the economy has begun to follow a particular pattern or trend. It is often a technical indicator that trails the price action of an underlying asset, and traders use it to generate transaction signals or confirm the strength of a given trend. Since these indicators lag the price of the asset, a significant move in the market generally occurs before the indicator can provide a signal. An example of a lagging indicator is a moving average crossover, because it occurs after a certain price move has already happened. Technical traders use a short-term average crossing above a long-term average as confirmation when placing buy orders, since it suggests an increase in momentum. The drawback of using this method is that a significant move may have already occurred, resulting in the trader entering a position too late. (Investopedia).
What is a Whipsaw?
A whipsaw is a condition in which a security’s price heads in one direction, but is followed quickly by a movement in the complete opposite direction.
“The act of getting whipsawed is most common for day traders or other short-term investors. Those who have a long-term, buy-and-hold approach to investing are often able to ride the volatility of the market and come out on the other side with positive gains” (Investopedia).
To avoid whipsaws completely when trading with the MACD Indicator, it is best to use the Centerline Crossover signal as the official buy or sell signal.