Technical Indicators: M (part 1)
MACD
The MACD (Moving Average Convergence/Divergence) is a momentum indicator used to show the relationship between two moving averages. The MACD was developed by Systems and Forecasts publisher, Gerald Appel.
The MACD is simple and reliable. It uses moving averages to include trend-following characteristics. These lagging indicators are turned into a momentum oscillator and plotted as a line that moves above and below zero with no upper or lower limits. The MACD proves most effective in studying wide-swinging trading markets.
MACD (2 lines)
MACD (2-lines) shows the relationship between a 26-day and 12-day Exponential Moving Average with a 9-day Exponential Moving Average (the "signal" or "trigger") line plotted on top to show buy/sell opportunities.
Three popular ways to use the MACD are crossovers, overbought/oversold conditions and divergences.
- Crossovers:
The basic MACD trading rule is sell when the MACD falls below its signal line and buy when the MACD rises above it. It is also common to buy/sell when the MACD goes above/below zero.
- Overbought/Oversold Conditions:
The MACD is also can be used as an overbought/oversold indicator. If the shorter moving average pulls away dramatically from the longer moving average and the MACD rises it is likely that the security price is overextended and will soon return to more realistic levels.
- Divergences:
Expect the end a current trend may be near when the MACD diverges from the price of a security. A bearish divergence occurs when the MACD is making new lows while prices fail to match these lows. Likewise, a bullish divergence occurs when the MACD is making new highs while prices fail to follow suit. Both of these divergences are most significant when they occur at relatively overbought/oversold levels.
MACD Histogram
Signals from the MACD Indicator can tend to lag behind price movements. The MACD Histogram is an attempt to address this situation showing the divergence between the MACD and its reference line (the 9-day Exponential Moving Average) by normalizing the reference line to zero. As a result, the histogram signals can show trend changes well in advance of the normal MACD signal.
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A buy signal is generated as the histogram crosses above the zero point. A sell signal is generated as the histogram crosses below zero.
Market Facilitation Index
Developed by Dr. Bill Williams, the Market Facilitation Index synthesizes both price and volume data in an effort to improve trading accuracy.
The calculation for the MFI is: [High] - [Low] / Volume
In his book Trading Chaos, Williams identified four types of trading sessions: Fakes, Fades, Squats, and Greens.
The combination of lowered volume with a rising MFI is known as a "Fake." As there is no real foundation for change behind a stock except for market activity on the floor, the price eventually reverses itself.
A "Fade" is when volume is down and the MFI is also down. In essence, the market is bored and interest in the stock fades. Expect the price to move in the opposite direction.
When volume is up while the MFI is down, the condition is referred to as a "Squat." Think of the stock crouching down like a sprinter before a race. Movement after the squat gives a clue to future to direction.
When volume and the MFI are both up, the situation is "Green." This is a strong signal to follow the trendline.
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