MACD indicator strategy / MACD formula helps one to understand immediate direction of the underlying. It is known as Moving Average Convergence Divergence which is abbreviated as MACD. The MACD indicator strategy was developed by Gerald Appel, publisher of Systems and Forecasts.
What is MACD Indicator?
- It is a Trend following momentum indicator
- It shows relationship between two moving average of prices.
- MACD is the difference between a 26 day EMA (exponential moving average) and 12 day EMA
- A 9 day EMA, called signal line is plotted on top of MACD to show buy/ sell opportunities.
MACD formula –
How does MACD work?
- There are three popular ways to use MACD – Crossover, overbought/ oversold condition, divergence
- MACD proves most effective in wide swinging trading market
- The signal shows effectively when to take a buy position and when to take a sell position
Crossovers – A basic trading rule is that sell the stock when the MACD falls below its signal line. Similarly one buys the stock when MACD rises above signal line. Another popular method is that a trader buys when MACD goes above zero and sell when MACD goes below zero.
Overbought/ Oversold conditions – When the shorter exponential moving average pulls away from longer moving average, i.e. the MACD rises, it is very likely that the security is overextending its position and will soon return to more realistic levels. This overbought/ oversold condition varies from security to security.
Divergence – An indication that the current trend is going to end and a reversal may take place occurs when the MACD diverges from stock price. Or it can be said when the MACD pulls away from trend shown by the price of the security. A bearish divergence occurs when MACD makes new lows the stock price fails to make new lows. A bullish divergence occurs when MACD makes new highs but the price doesn’t. These divergences are more significant when they occur at relatively overbought/ oversold levels.
Conclusion – MACD indicator strategy works best if it is combined with Williams Percent R. A combined study of these two makes trading more successful.