Moving Average Convergence Divergence (MACD)

Moving Average Convergence Divergence (MACD)

Although the MACD is a more complex mathematical indicator, its application is relatively simple.

For the serious technical analyst:

The Moving Average Convergence/Divergence indicator is calculated by subtracting the value of a 26 period exponential moving average from the 12 period exponential moving average. The 12 and 26 period averages are most commonly used, but the user can change them on most charting tools. The product of the difference between the two exponential moving averages is called the indicator line. On top of this indicator line a signal line is displayed that usually consists of a 9 period exponential moving average of the indicator line.

Application:

The trading rules are very similar to those applicable to moving averages. The trader will sell whenever the indicator line (MACD) falls below the signal line. Conversely he will buy whenever the indicator line rises above the signal line. The buy or sell signal is stronger if it occurs in the top or bottom quartile.  For example: a buy signal in the bottom quartile or a sell signal in the top quartile will be stronger and more successful than around the middle of the graph.

MACD can also be used to spot divergence in share prices. This is extremely useful in spotting market tops and bottoms. Divergence occurs when the share price makes a new high, but the indicator line does not make a new high. This will be the first indication that the Bull Run is losing steam. It can best be explained by looking at an example.

MACD is a very good indicator to use for buying and selling signals.  It normally gives an earlier warning than simple moving averages, but like moving averages, it works best in a trending market.

Example:

On 20 April Sasol gave a sell signal at R396 when the indicator line crossed below the signal line in the top quartile of the MACD oscillator. On 27 June it gave a Buy signal at R366 when the indicator line crossed above the signal line in the bottom quartile. On 16 August a sell signal was given at R399 for a 9% per share profit.

The crossing of the lines in the middle of September should be ignored because it did not occur in the top or bottom quartile. A Buy signal was again given on 5 October at R382 and is still accumulating profits. Current price was R442 for a potential profit of 15%.

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