Devoted to understanding the basics and fundamentals of investing

Today I would like to explain an indicator that has stood the test of time, the Moving Average Convergence/Divergence or MACD indicator.  It was developed by Gerald Appel.  From the name, you can see that it is built on moving averages.

In its original form, the MACD takes the 26 day exponential moving average of the closing price and subtracts it from the 12 day exponential moving average.  Moving averages are lagging indicators, but by using the exponential moving average which gives more weight to recent measurements, the lag is shortened.  The result is plotted on a graph.  It will oscillate around zero and is not bound unlike the RSI and the Stochastic Oscillators I previously discussed.

To get a trigger, the 9 day exponential moving average is also calculated and plotted on the graph.  Signals are triggered when

1. the MACD moves above or below zero,
   
2. when it moves above or below the 9 day trigger line, or
3. when there is a positive or negative divergence.

The most reliable and least common signal is from positive or negative divergences.  Remember that a positive divergence is when the MACD is moving up but the price of the stock is moving down.  This is bullish.  A negative divergence is when the MACD is moving down but the stock is moving up.  This is bearish and would alert the user to a possible sale.

The most common signal and the least reliable is when the MACD crosses the 9 day EMA trigger line.  This can result in being whip sawed and losing money due to transaction costs.  9-day crossovers should always be confirmed by other signals before being used to trade.

I am only going to write a couple more posts on technical trading.  I will discuss volume and open interest in one post, and then I will try to share Bob Hansell's technical trading system that he described in a couple of comments he left on the site.  I hope this series has helped you understand the vocabulary of technical trading a little better.  To become a good trader, I would read much more extensively in the literature and would find a mentor if I could.  There is much art to this style of trading.