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MACD

We started our indicator series last week with moving averages and I would like to continue this week with the MACD. 

MACD stands for Moving Average Convergence Divergence.  It is another lagging indicator that represents trends on the chart.  It is based on moving averages hence the name.  That is also why it is a lagging indicator as you have already learned in the commentary on moving averages.  The MACD is made up of two exponential moving averages (EMAs); a mid term average and a short term average.  As with any other indicator you can change the time line by changing the input characteristics.  So if you want to use the MACD on a long term buy and hold type stock you would need to move your EMAs out to a mid term and a long term. 

Common EMAs
If you look at charting websites or software packages I believe the most common EMAs used are 26 and 12.  The EMAs are represented in days so in this case the 26 days is the mid term EMA and 12 is the short term EMA.  There is a 3rd EMA which is present with the MACD.  It is called the trigger line.  In the standard formula it is typically represented with a 9 day EMA. 

The Purpose of the MACD
So what does the MACD do for you as a trader The purpose of the MACD is to measure the difference between the two moving averages which you have specified.  It is a gauge of how quickly the stock is reacting and moving either positively or negatively.  If the MACD is positive (above the 0 mark) this means the short term moving average is trading above the longer term.  If the MACD is negative (below the 0 mark) this means the short term average is trading below the longer term. 

What does this all mean 
Well positive movement in the moving averages is a way to start identifying stocks that have the potential for positive movement.  Negative movement in the MACD would be indicative of a potential negative move in a stock. 

The angle of the movement is also something to pay attention to.  A very steep incline or decline will be a key to determining the strength behind any potential move.  The steeper the angle the more rapidly the stock price will move. 

But if it is a lagging indicator how can I use it to predict future direction
The rate of change in the MACD can be used to help predict the most likely direction for the stock to be moving in the future.  As I have stated before you should not be relying on one indicator alone.  The MACD used in conjunction with other indicators will give you the most accurate picture of the potential direction in a stock. 

What we look for in the MACD is a crossing of the MACD line (the darker/thicker line) over its trigger line.  This signifies a potential move is coming.  If the MACD crosses both the trigger line and the 0 mark at or close to the same time that is even more bullish situation.  The inverse is true as well.  If the cross is negative the movement is likely to be negative as well.  The greater the angle the stronger the potential move. 

Divergence between the indicator and the current trend within the stock is a very good area to focus.  If a stock is still declining slightly but the MACD has turned north that would be a very bullish sign.  So even with this being a lagging indicator we can still use it in our toolbox to predict future movement.





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