Moving Average Convergence/Divergence

Description:

The MACD (Moving Average Convergence/Divergence) is a trend-following momentum indicator that shows that relationship because two moving averages of prices. The MACD was developed by Gerald Apple, publisher of System 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. (Appel specifies exponential moving averages as percentages. Thus, he refers to these three moving averages as 7.5 percent, 15 percent, and 20percent, respectively.)

Interpretation

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. It is also popular to buy/sell when the MACD goes above/below zero.

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 conditions 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. 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.