Spot changes in price trends and momentum using the MACD
Jason Brizic
August 5th, 2011
I love the moving average convergence-divergence indicator (aka the “Mac-Dee”) because it allows me to spot changes in price trends and momentum.
Developed by Gerald Appel in the late seventies, Moving Average Convergence-Divergence (MACD) is one of the simplest and most effective momentum indicators available. MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. As a result, MACD offers the best of both worlds: trend following and momentum. MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, centerline crossovers and divergences to generate signals. Because MACD is unbounded, it is not particularly useful for identifying overbought and oversold levels.
I use the commodity channel index (CCI) for identifying overbought and oversold levels. To learn more about the CCI see this tip of the week: http://bit.ly/q2loA8
Now back to the MACD. The standard MACD is the 12-day Exponential Moving Average (EMA) less the 26-day EMA. Closing prices are used for these moving averages. A 9-day EMA of MACD is plotted with the indicator to act as a signal line and identify turns. The MACD-Histogram represents the difference between MACD and its 9-day EMA, the signal line. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.
As its name implies, MACD is all about the convergence and divergence of the two moving averages. Convergence occurs when the moving averages move towards each other. Divergence occurs when the moving averages move away from each other. The shorter moving average (12-day) is faster and responsible for most MACD movement. The longer moving average (26-day) is slower and less reactive to price changes in the underlying security.
MACD oscillates above and below the zero line, which is also known as the centerline. These crossovers signal that the 12-day EMA has crossed the 26-day EMA. The direction, of course, depends on direction of the moving average cross. Positive MACD indicates that the 12-day EMA is above the 26-day EMA. Positive values increase as the shorter EMA diverges further from the longer EMA. This means upside momentum is increasing. Negative MACD indicates that the 12-day EMA is below the 26-day EMA. Negative values increase as the shorter EMA diverges further below the longer EMA. This means downside momentum is increasing.
In the example above, the yellow area shows MACD in negative territory as the 12-day EMA trades below the 26-day EMA. The initial cross occurred at the end of September (black arrow) and MACD moved further into negative territory as the 12-day EMA diverged further from the 26-day EMA. The orange area highlights a period of positive MACD, which is when the 12-day EMA was above the 26-day EMA. Notice that MACD remained below 1 during this period (red dotted line). This means the distance between the 12-day EMA and 26-day EMA was less than 1 point, which is not a big difference.
Signal line crossovers are the most common MACD signals. The signal line is a 9-day EMA of MACD. As a moving average of the indicator, it trails MACD and makes it easier to spot turns in MACD. A bullish crossover occurs when MACD turns up and crosses above the signal line. A bearish crossover occurs when MACD turns down and crosses below the signal line. Crossovers can last a few days or a few weeks, it all depends on the strength of the move.
Due diligence is required before relying on these common signals. Signal line crossovers at positive or negative extremes should be viewed with caution. Even though MACD does not have upper and lower limits, chartists can estimate historical extremes with a simple visual assessment. It takes a strong move in the underlying security to push momentum to an extreme. Even though the move may continue, momentum is likely to slow and this will usually produce a signal line crossover at the extremities. Volatility in the underlying security can also increase the number of crossovers.
Chart 2 shows IBM with its 12-day EMA (green), 26-day EMA (red) and MACD (12,26,9) in the indicator window. There were eight signal line crossovers in six months: four up and four down. There were some good signals and some bad signals. The yellow area highlights a period when MACD surged above 2 to reach a positive extreme. There were two bearish signal line crossovers in April and May, but IBM continued trending higher. Even though upward momentum slowed after the surge, upward momentum was still stronger than downside momentum in April-May. The third bearish signal line crossover in May resulted in a good signal.
Centerline crossovers are the next most common MACD signals. A bullish centerline crossover occurs when MACD moves above the zero line to turn positive. This happens when the 12-day EMA of the underlying security moves above the 26-day EMA. A bearish centerline crossover occurs when MACD moves below the zero line to turn negative. This happens when the 12-day EMA moves below the 26-day EMA.
Centerline crossovers can last a few days or a few months. It all depends on the strength of the trend. MACD will remain positive as long as there is a sustained uptrend. MACD will remain negative when there is a sustained downtrend. Chart 3 shows Pulte Homes (PHM) with at least four centerline crosses in nine months. The resulting signals worked well because strong trends emerged with these centerline crossovers.
There are more examples available at StockChart.com’s chart school: http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:moving_average_conve
I believe that the best opportunities to buy high dividend stocks at low prices can be identified when the MACD is below the centerline and after bullish signal line crossover. I perform fundamental analysis first to decide what stocks to buy. Next I use the MACD, CCI, and Bollinger Bands to time my purchase or sale of stocks.
I used this technique to buy gold at $840 per ounce in December 2009. Gold has amazing fundamentals given the historic fiat money printing be perpetrated by the Federal Reserve. Then I examined the technical indicators. The MACD (the black line) was below the centerline and it had just crossed above the signal line (the red line).
What works for commodities works for stocks as well. I’ve been following SeaDrill (SDRL) for about six months. Their chart shows how the MACD can help time a purchase. I think SeaDrill should be bought at around $15.00 per share. The MACD showed a steady decline in momentum during the first six months of 2010. In June 2010 the MACD crossed the centerline into negative territory, then in July it turned upward and did a bullish signal line crossover. The stock price bottomed at $16.64 just before these technicals came together
AT&T’s MACD signaled a reversal in November 2008 and March 2009 along with the CCI and it Bollinger Bands.
Pick one of your favorite stocks and type its ticker into the Ticker Symbol field. Here is the link to the chart with the MACD and CCI set up for you:
http://stockcharts.com/h-sc/ui?s=$SPX&p=W&b=5&g=0&id=p16270535585
Was the best time to buy your favorite stock when the MACD met my criteria above and in the linked CCI Tip of the Week?
For more tips, go here:
http://www.myhighdividendstocks.com/category/tip-of-the-week
No comments:
Post a Comment