Forum Archive Index - November 2001

[Phaedrus <Phaedrus@techemail.com>]

 The MACD ("Moving Average Convergence/Divergence") is a trend following 
momentum indicator that shows the relationship between two moving averages of 
prices. The MACD was developed by Gerald Appel, publisher of Systems and 
Forecasts.

The MACD is the difference between a 26-day and 12-day exponential moving 
average. A 9-day exponential moving average, called the "signal" or "trigger" 
line is plotted on top of the MACD to show buy/sell opportunities. The MACD 
proves most effective in wide-swinging trading markets. There are three popular 
ways to use the MACD: crossovers, overbought/oversold conditions, and 
divergences.

Crossovers
The basic MACD trading rule is to sell when the MACD falls below its signal 
line. Similarly, a buy signal occurs when the MACD rises above its signal line. 
Crossovers near the zero line are usually best ignored. Buy signals occuring 
above the zero line (overbought) would of course be ignored. 

Overbought/Oversold Conditions
The MACD is also useful as an overbought/oversold indicator. When the shorter 
moving average pulls away dramatically from the longer moving average (i.e., 
the MACD rises), it is likely that the security price is overextending and will 
soon return to more realistic levels. MACD overbought and oversold levels vary 
from security to security.

Divergences
An indication that an end to the current trend may be near occurs when the MACD 
diverges from the security. For example, a bearish divergence occurs when the 
MACD is making new lows while prices fail to reach new lows. A bullish 
divergence occurs when the MACD is making new highs while prices fail to reach 
new highs. Both of these divergences are most significant when they occur at 
relatively overbought/oversold levels.

 MACD is only used to trade trends. It gives unprofitable signals in trading 
ranges, as do all trend indicators. Similarly, it is a lagging indicator, it 
gives "late" signals - entry signals are only given when the trend is underway, 
and exit signals are usually well after the trend has ended. This 
characteristic can be improved by use of the MACD histogram. This is simply the 
difference between the two existing MACD lines, plotted using vertical bars as 
a histogram. Notice how the point where the histogram reverses tends to be much 
closer to the peaks and troughs of the trend than the crossing of the MACD 
lines. The basic trading rule is to buy when the MACD histogram turns up when 
below the centreline, and sell when it turns down when above the centreline. As 
before, signals given well away from the zero line are stronger.

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