The MACD Indicator: Understand and Apply
The MACD Indicator is a momentum indicator that can play a part in determining whether a trend has completed or is just beginning. Depending on the time frame, the MACD can help you to find entry and exit points within the positive and negative turns of momentum.
MACD Indicator – A Duel Threat
Most traders don’t really understand what the MACD indicator is, aside from some bars that go up and down and some lines that somehow move with it. At the core, the MACD indicator is nothing more than a 12 and a 26 exponential moving average (EMA). The bars (or Histogram) displayed within the MACD are calculated by analyzing the EMAs, as you’ll see in a minute.
The chart below shows the 12 and 26 EMAs on GLD. The 12 moves faster and reacts quicker to price action, while the 26 reacts slower.
Momentum Within The MACD Indicator
A. The price is dropping. The 12 EMA reacts faster with price action and moves further away from the 26. The distance between the 2 EMAs getting bigger, represented in the histogram, becoming larger to the downside, indicating growing bearish momentum.
B. The price turns and begins to increase. The 12 EMA is moving closer to the 26. As a result, the histogram becomes smaller as well. The bearish momentum is fading.
C. The price moves up quickly, and the 12 EMA is following faster than the 26. Again, the distance between the two is getting bigger, resulting in the histogram increasing to the upside. This is an indication that bullish momentum is growing.
When the histogram moves, momentum is moving with it. The histogram’s direction and angle provide data about the slope of the EMAs, regardless of whether the bars are negative or positive.
A positive MACD displays the 12 EMA above the 26, while a negative MACD displays the 12 below the 26. As a result, when the 12 and the 26 cross, the MACD crosses from positive to negative.
Divergences can indicate when a trend is over and help you recognize the right time to take profits. Divergence is also capable of providing you with an early entry signal in the opposite direction.
A divergence is kind of like a discrepancy between the chart and indicator. In this case, it’s when the price action points in one direction while the MACD lines point in the other. I’ve pulled the hourly chart for NK to give a good example of divergence here.
As usual, using only one indicator (such as the MACD) to generate trade signals will likely not provide the results you’re looking for. Understanding several indicators and using them with each other will help to confirm trade indications. Adding the MACD to your indicators and understanding how to use it correctly can substantially increase your ability to trade effectively.
Sites like SwingTradeBot offer scans that can point out crossover signals for you. This makes it easy to see which stocks may be changing momentum on a daily basis.
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