20 September 2009

MACD Histogram

The signals from the MACD indicator tend to lag price movements. The MACD Histogram attempts to address this problem by plotting the distance between MACD and its signal line. Because of this, the histogram signals trend changes well in advance of the normal MACD signal, but is less reliable and should be confirmed by other indicators.

Only trade with Histogram signals when the market is trending.

The MACD Histogram can also be used to track longer cycles, using weekly or monthly data.

Trading Signals

Use Stop Losses with all trades.

Ranging Markets

Signals are stronger if

There is a bullish divergence on the Histogram; or

The signal occurs far from the zero line.

Disregard signals close to the zero line unless confirmed by a divergence.

Go long when the MACD Histogram turns up below zero.

Close the position when there is a signal to go short.

Go short when MACD Histogram turns down above zero.

Close the position when there is a signal to go long.

Trending Markets

Only trade in the direction of the trend. Signals close to the zero line are accepted provided the trend is intact.

Go long when the MACD Histogram turns up below zero.

Go short when MACD Histogram turns down above zero.

Use a trend indicator, such as a moving average, to exit from trends.

Intel Corporation is shown with   MACD histogram and   21-day exponential moving average. Trendlines show divergences.

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Mouse over chart captions to display trading signals.

Price is ranging - indicated by the flat MA. Go long [L] when the histogram turns up (far from the zero line). Place a stop below the recent Low.

Go short [S] as the histogram turns down (far from the zero line). Place a stop above the recent High.

Go long [L] - the histogram turns up and is reinforced by a bullish divergence. Place a stop below the recent Low.

Go short [S] as the histogram turns down - reinforced by a bearish divergence. Place a stop above the recent High.

Ignore the signal as it is too close to the zero line.

Go long [L] as the histogram turns up when well below zero. Place a stop below the recent Low.

A further signal to go short [S]. Place a stop above the recent High.

Go long [L] - the histogram has turned up and is reinforced by a bullish divergence. Price has broken clear of the trading range and the MA is rising - exit [X] when price closes below the MA.

Setup

The default settings are:

Slow moving average - 26 days

Fast moving average - 12 days

Signal line - 9 day moving average of the difference between fast and slow.

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All moving averages are exponential.

The MACD histogram is calculated as the MACD indicator minus the signal line. Observe that:

When MACD is above the signal line then the histogram is positive.

When MACD is below the signal line then the histogram is negative.

When the gap between the MACD and its signal line is widest then the histogram registers its highest (or lowest) readings.

The histogram is at zero when MACD and the signal line cross (the signal for trading with theMACD).

The histogram turns back towards the zero line when MACD and the signal line converge, well in advance of them actually crossing.

The MACD Histogram is more suited to traders than investors: signals are generated a lot earlier in the trend but are less reliable as a consequence. It is essential that stop losses are employed on every trade and adjusted over time to protect profits

Set up the MACD so that the first moving average is half the length of the cycle being tracked. The second moving average should be half the length of the first and the third (signal line) moving average can be varied according to the sensitivity required.

Dr Alexander Elder, in Trading for a Living, uses an MACD Histogram as the first screen in his Triple Screen Trading system. Weekly moving averages are used, set at 26, 12 and 9 weeks. WeeklyMACD readings are more reliable but there is a lag effect (signals only occur once a week). Alternatively, use an equivalent daily MACD (e.g. 130 days, 60 days and 45 days) with a filter (e.g. 3 consecutive bars) or a signal line created with Indicator Smoothing.

EXAMPLE

FedEx is shown with  150-day exponential moving average and  MACD Histogram (100-day, 50-day and 30-day moving averages) and  9-day exponential signal line (  optional indicator smoothing).

The histogram crosses to above the signal line at [1], signaling that the market can now be traded long.

Conditions remain favorable until [8], when the histogram crosses to below the signal line. Place a sell-stop below the Low of the signal day. We are stopped out the next day.

Entry is timed using a short-term oscillator and trailing buy and sell stops:

FedEx is shown below with  150-day exponential moving average and 9-day Stochastic  %K and  %D.

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Entry is timed using a short-term oscillator and trailing buy and sell stops:

FedEx is shown below with   150-day exponential moving average and 9-day Stochastic   %K and   %D.

The MACD histogram signals [1] that conditions are favorable for long trades.

%K crosses below the oversold level at [2]. Place a buy-stop above the day's High.

The stop is not activated and the day has a lower High. Move the buy-stop to just above the High.

Price moves up stopping us in. Place a stop loss below the Low of day [3].

We are stopped out when price falls below the stop level on day [5]. The same day provides us with a signal to go long - place a buy-stop above the High of day [5].

Price moves lower - move the buy-stop down to above the High on day [6].

Price moves higher, stopping us in. Place a stop loss below the Low of day [6].

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The long position is closed when MACD histogram closes below the signal line at [8] - refer to the first chart. Place a sell-stop below the Low of the signal day. We are stopped out the next day.

Formula

To calculate the MACD Histogram:

Microsoft Corporation is plotted with   MACD,   MACD signal line and   MACD Histogram.

The MACD histogram is calculated as the MACD indicator minus the signal line. Observe that:

When MACD is above the signal line then the histogram is positive.

When MACD is below the signal line then the histogram is negative.

When the gap between the MACD and its signal line is widest then the histogram registers

its highest (or lowest) readings.

The histogram is at zero when MACD and the signal line cross (the signal for trading with

theMACD).

The histogram turns back towards the zero line when MACD and the signal line converge,

well in advance of them actually crossing.

My Toolbox : Dr Alexander ElderMy approach is based on the Triple Screen trading system which I developedin the 1980s and continue to improve to this day. Since every marketcan be analyzed in several timeframes, Triple Screen insists that youbegin by defining your favorite timeframe in which you like to work, suchas daily, hourly, or weekly chart. Once you know what your favorite is,do not look at it! You must first go to the timeframe one order of magnitudehigher, make your strategic decision there, and return to your

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favorite timeframe only to make a tactical decision—where to buy orsell—and then trade only in the direction of the longer timeframe.Since my favorite timeframe tends to be the daily, I use weekly chartsto make my strategic decisions, and return to dailies to implement them.The weekly and daily charts are my first two screens. The third screen isthe entry method, for which you can either use an intraday chart or simplyplace an order using a daily chart.

MOVING AVERAGESPrice is a consensus of value at the moment of a trade. A moving average(MA) reflects an average consensus of value in its time window. Ifprice is a snapshot, a moving average is a composite photograph. It providestwo important messages to traders. First, its slope identifies thedirection of change in the public’s mood. A rising moving averagereflects growing optimism (bullish), while a falling MA reflects growingpessimism (bearish).Another important role of the MA is differentiating between what I call“value trades” and “greater fool theory” trades. If you buy near the movingaverage, you’re buying value. A person who buys well above themoving average is in effect saying—”I’m a fool, I’m overpaying, but I hopeto meet a greater fool down the road.” There are very few fools in thefinancial markets, and a person who keeps buying above value is notlikely to win in the long run. He may get lucky once in a while, but buyingnear value is a much more sensible strategy. I like using two EMAs onmy charts, one showing a longer-term, and another a shorter-term, consensusof value. I call the area between them “the value zone.” There areseveral types of moving averages, but I always use exponential ones. EMAsare more sensitive to incoming prices and less sensitive to old prices.

ENVELOPES OR CHANNELSOne of the very few scientifically proven facts about the markets is thatprices oscillate above and below value. You could say that markets aremanic-depressive—rising too high and falling too low, only to swing backto the normalcy of the value zone.There are several types of channels, and my favorite is a straight envelope—the lines above and below the EMA, both parallel to it. A welldrawnchannel fits like a good shirt, covering the body of prices, withonly the most extreme prices—the neck and the wrists—sticking out.Amateurs love to buy breakouts, but professionals tend to look for buyingopportunities near the lower channel line and shorting opportunitiesnear the upper channel line.Some traders like to use standard deviation channels, often calledBollinger Bands, which expand and contract in response to marketvolatility. They are only useful for options traders because volatility is akey factor in option pricing. If you trade stocks, futures, or forex, you arebetter off with straight envelopes.

MACD LINES AND MACD-HISTOGRAMMoving Average Convergence-Divergence (MACD) is an indicator whosefast line represents the short-term consensus of value, and the slow linethe long-term consensus. When the fast line rises above the slow line, itshows that bulls are dominant, and when the fast line is below the slowline, the bears are in charge.MACD-Histogram measures the power of bulls and bears by trackingthe difference between the two MACD lines. When their spread increases,

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it shows that the dominant market group is becoming stronger—it is agood time to trade in that direction. Divergences between peaks and bottomsof MACD-Histogram and price are among the strongest signals intechnical analysis.MACD-Lines and MACD-Histogram are derived from three exponentialmoving averages of closing prices. Their settings—12, 26, and 9—havemigrated into trading software and become default settings in many packages.In writing my books, I used those settings to illustrate this indicator.What settings should you use? If you want to use the same ones aseveryone else, use 12, 26, and 9 because the crowd is basically lazy anduses the default values. You can also choose settings that are a little fasteror a little slower. Think about it and experiment with the values, or usethe defaults.

FORCE INDEXEverybody watches prices, but it is volume that moves them. Volume reflectsthe intensity of traders’ commitment, the heat of their exuberance,the depth of their fear. Instead of looking at a plain plot of volume, I useForce Index, which links volume with price changes. Divergences betweenForce Index and prices tell me when a trend is becoming weakand ready to reverse. By contrast, new highs of Force Index tell me thatthe trend is strong and likely to continue.

THE IMPULSE SYSTEMThis system identifies bullish and bearish phases in any market or timeframeby combining two indicators. The slope of the fast moving average identifiesthe inertia of the market, while the slope of MACD-Histogramidentifies the push of the bulls or bears. The Impulse system gives a buysignal when both the EMA and MACD-Histogram rise, and a sell signalwhen both decline. When the two indicators get in gear, they mark especiallybullish or bearish periods. Just as importantly, the Impulse showswhen bulls or bears start slipping, and a trend starts growing weaker.One of my Traders’ Camps graduates, a brilliant programmer namedJohn Bruns, programmed the Impulse system for several popular softwarepackages, coloring each bar in accordance with the Impulse system.When the EMA and MACD-Histogram rise at the same time, the marketis in gear to the upside and the bar turns green. When both fall, bears arein control and the bar is red. When the two indicators point in oppositedirections the bar is blue.

The Impulse The slope of The slope of The tradingSystem EMA MACD-Histogram messageGreen Up Up Long or stand aside; no shortingRed Down Down Short or stand aside; no buyingBlue Up Down Either long or shortBlue Down Up Either long or short

The Impulse system works best as a censorship method. When theImpulse is green, you may buy or stand aside but absolutely no shortingis permitted. When the Impulse is red, you may go short or stand asidebut buying is prohibited. I wait for the Impulse system to go “off green”before shorting and “off red” before buying.Some programs do not allow users to change the color of their bars onthe basis of conditional formatting, but you can still identify green or redImpulse by noticing the slope of the EMA and MACD-Histogram.

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Adapted from Entries & Exits by Dr. Alexander Elder,John Wiley & Sons, Inc., 2006……………………………………………………………………….

Author(s): “Understanding MACD”

Gerald Appel Click here to view other Titles by this author. 

Gerald Appel is a world famous author and lecturer. A frequent guest on television and radio, he has appeared on Wall Street Week with Louis Ruykeyser and his articles and/or articles about him have appeared in Money Magazine, Barron’s, Technical Analysis of Stocks and Commodities Magazine, Stocks Futures and Options Magazine, Wealth Magazine, the New York Times, Forbes, Kiplinger’s Magazine, and elsewhere. He is the founder of Signalert Corporation, an investment advisory firm that manages more than $300 million in client assets and is the author of numerous books and articles regarding investment strategies, including Technical Analysis: Power Tools for the Active Investor (Financial Times Prentice Hall, 2005).

Edward D. Dobson Click here to view other Titles by this author. 

Edward Dobson was born in California and raised in South Carolina. At age 12, his father instilled in him an interest for investing in stocks. This became a life long passion, which came to encompass trading in securities, options and futures.

After college and military duty, he was a broker with Smith Barney and Paine Webber for 23 years, specializing in options and futures. In 1992, he left the brokerage business to devote full time to his publishing business, Traders Press (founded in 1975), and to trading. He is currently an active trader and still active in his business.

Edward Dobson is the president and sole owner of Traders Press, Inc. You can read more about him in the History of Traders Press.

Synopsis:

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Are You an MACD Expert Yet? If not, you can be soon! Our latest publication is the definitive reference on this widely followed yet little understood technical indicator. Order your copy today!

Description:

Click here for the E-Book Edition : “Understanding MACD”

MACD (Moving Average Convergence-Divergence) is a highly effective and practical trend-following indicator which is widely available on most technical analysis software programs. Traders and investors with this indicator at their disposal would be well advised to learn as much as they can about it and how to use it to improve their trade timing and selection.

This comprehensive guide to MACD is a one-of-a-kind one-stop reference that will prove a valuable addition to your trading library. It includes a bullet point summary overview of MACD, a detailed bibliography detailing all known references and articles relating to MACD, with annotation showing unique points covered in each source, and a major research report on MACD written by and originally published by Gerald Appel (and priced at $50 for this report alone). This report, written by the originator of this indicator, is the most definitive and in-depth material available on MACD. It alone is worth far more than the modest price of this booklet.

Publisher’s Foreword

I first learned about MACD (Moving Average Convergence-Divergence) in the early 1980’s, shortly after Gerald Appel published his groundbreaking research report which “revealed” this new technical indicator. In 1986, he updated and expanded his original report, and shared with the reader how he used and interpreted it in his own market analysis. This updated report, reproduced in its entirety, is the heart of this work, which is intended to give the reader a basic understanding and knowledge of MACD and how to use it effectively in market analysis and timing. It is my belief that the most effective way to achieve this goal is to hear it straight from the “master” on the subject.

The idea for this book came about years ago one night when my old friend Gerald and I were having dinner with our mutual friend Alexander Elder in Chicago. It has been a long time in the making since then. Originally, Gerald felt that the original manuscript and charts would need to be updated with current examples and commentary. He didn’t even have a copy of the report, which had gone out of print and was no longer available. After a diligent search I was able to locate an old used copy, which was forwarded to him to be updated and revised. Surprisingly, after looking it over closely (this being some 20 years after it was written), he advised that he felt it was “OK” as it was, and needed no updating. I feel that this attests to the fact that markets, over time, no not really “change”, and some indicators and principles stand the “test of time” and are just as valid today as they were decades ago. In terms familiar to systems developers, they are “robust”.My special thanks to Shelley Mitchell, whose painstaking research and diligent effort produced the listing of articles and annotated bibliography which add a valuable dimension to this work.

It is my hope that this reprinted material, along with the annotated bibliography of articles and references and a few brief comments of my own, will prove helpful to you in your pursuit of trading excellence. Introduction There has long been a need for this booklet. MACD (Moving Average Convergence-Divergence) has long been one of the most popular and widely available

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technical indicators since it was developed by Gerald Appel in the late 1970’s. However, since Appel’s last published research on the subject, published in 1986, went of out print and was no longer available, there has been no work solely dedicated to this topic. There are a number of excellent books which contain discussion and explanation of MACD, but only in passing and not in depth. Research of all past literature dealing with MACD shows that Appel’s own in-depth work on the subject is the best resource for learning and mastering the use of this indicator….thus, this work is reprinted herein in its entirety. As explained in the Foreword, though this material is over twenty years old, it is still as relevant and applicable today as when it was originally written.

Those interested in furthering their knowledge of MACD are encouraged to take special note of the articles listed herein, and of the references in other works in the bibliography. The most notable of these works is Appel’s own “Technical Analysis: Power Tools for Investors”, which has a major section and treatment of MACD, and which was recently published in 2005. This book is a valuable reference and resource for serious traders and investors.

Of all the many technical indicators and studies available today in technical analysis software, it is my belief that MACD is one of the most helpful and reliable. An old acquaintance of mine, who spent literally thousands of hours over a period of years studying various technical indicators, eventually came to the conclusion that the only two indicators truly worth using were ADX and MACD, applied over multiple time frames simultaneously. The MACD histogram, which shows the difference between the two MACD lines, was preferred over the two lines themselves. When this histogram crosses the zero line in either direction, it shows a crossing of the two lines. When the histogram reading peaks and turns up or down, indicating that the differential between the lines has run out of momentum and begun to decrease, is an early signal that occurs well before an actual crossing of the lines. My acquaintance used this occurrence as one of the main components of a trading methodology (coupled with ADX readings).

I first became aware of the use of the MACD histogram in the late 1980’s, when my friend Alex Elder used and discussed it extensively in a market letter he published at that time. Another reference I highly recommend for discussion of MACD and the Histogram is the relevant section in Elder’s classic “Trading for a Living”, one of the best and most helpful trading books ever written, in my opinion.

Table of Contents:

Publisher’s Foreword

Introduction

Key Points

MACD Report

The Basic Structure of MACD

Introducing the Signal Line

The Basic Buy and Sell Signals

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Using Divergences to Recognize the Most Reliable Signals

Comparing MACD to a Price Momentum Oscillator

Comparing MACD to the Relative Strength Indicator

Combining Two MACD Combinations for More Accurate Signals

MACD During a Strongly Uptrending Period

MACD During a Strongly Downtrending Period

Stop Losses for Unsuccessful Trades

Using Trendlines to Confirm Signals

Long Term MACD Signals

Using Monthly MACD

MACD As A Day Trading Tool

Using Time Cycles with MACD

When MACD Does Not Provide Timely Signals

Amazing Ability of MACD to Catch the Ends of Significant Declines

MACD and the 5-Minute Tick Chart

MACD and the 71 Day Market Cycle

Shifting Your Sell Parameters Because of Divergence

A Difficult Climate for MACD

Computing and Maintaining Exponential Moving Averages

Summary of MACD Procedures

Sell Procedures

Understanding MACD by Gerald Appel and Edward Dobson

Synopsis:

Are You an MACD Expert Yet? If not, you can be soon! This is the definitive reference on this widely followed yet little understood technical indicator.

11

Description:

MACD (Moving Average Convergence-Divergence) is a highly effective and practical trend-following indicator which is widely available on most technical analysis software programs. Traders and investors with this indicator at their disposal would be well advised to learn as much as they can about it and how to use it to improve their trade timing and selection.

This comprehensive guide to MACD is a one-of-a-kind one-stop reference that will prove a valuable addition your trading library. It includes a bullet point summary overview of MACD, a detailed bibliography detailing all known references and articles relating to MACD, with annotation showing unique points covered in each source, and a major research report on MACD written by and originally published by Gerald Appel (and priced at $50 for this report alone). This report, written by the originator of this indicator, is the most definitive and in-depth material available on MACD. It alone is worth far more than the modest price of this booklet.

Publisher’s Foreword

I first learned about MACD (Moving Average Convergence-Divergence) in the early 1980’s, shortly after Gerald Appel published his groundbreaking research report which “revealed” this new technical indicator. In 1986, he updated and expanded his original report, and shared with the reader how he used and interpreted it in his own market analysis. This updated report, reproduced in its entirety, is the heart of this work, which is intended to give the reader a basic understanding and knowledge of MACD and how to use it effectively in market analysis and timing. It is my belief that the most effective way to achieve this goal is to hear it straight from the “master” on the subject.

The idea for this book came about years ago one night when my old friend Gerald and I were having dinner with our mutual friend Alex Elder in Chicago. It has been a long time in the making since then. Originally, Gerald felt that the original manuscript and charts would need to be updated with current examples and commentary. He didn’t even have a copy of the report, which had gone out of print and was no longer available. After a diligent search I was able to locate an old used copy, which was forwarded to him to be updated and revised. Surprisingly, after looking it over closely (this being some 20 years after it was written), he advised that he felt it was “OK” as it was, and needed no updating. I feel that this attests to the fact that markets, over time, no not really “change”, and some indicators and principles stand the “test of time” and are just as valid today as they were decades ago. In terms familiar to systems developers, they are “robust”.My special thanks to Shelley Mitchell, whose painstaking research and diligent effort produced the listing of articles and annotated bibliography which add a valuable dimension to this work.

It is my hope that this reprinted material, along with the annotated bibliography of articles and references and a few brief comments of my own, will prove helpful to you in your pursuit of trading excellence. Introduction There has long been a need for this booklet. MACD (Moving Average Convergence-Divergence has long been one of the most popular and widely available technical indicators since it was developed by Gerald Appel in the late 1970’s. However, since Appel’s last published research on the subject, published in 1986, went of out print and was no longer available, there

12

has been no work solely dedicated to this topic. There are a number of excellent books which contain discussion and explanation of MACD, but only in passing and not in depth. Research of all past literature dealing with MACD shows that Appel’s own in-depth work on the subject is the best resource for learning and mastering the use of this indicator….thus, this work is reprinted herein in its entirety. As explained in the Foreword, though this material is over twenty years old, it is still as relevant and applicable today as when it was originally written.

Those interested in furthering their knowledge of MACD are encouraged to take special note of the articles listed herein, and of the references in other works in the bibliography. The most notable of these works is Appel’s own “Technical Analysis: Power Tools for Investors”, which has a major section and treatment of MACD, and which was recently published in 2005. This book is a valuable reference and resource for serious traders and investors.

Of all the many technical indicators and studies available today in technical analysis software, it is my belief that MACD is one of the most helpful and reliable. An old acquaintance of mine, who spent literally thousands of hours over a period of years studying various technical indicators, eventually came to the conclusion that the only two indicators truly worth using were ADX and MACD, applied over multiple time frames simultaneously. The MACD histogram, which shows the difference between the two MACD lines, was preferred over the two lines themselves. When this histogram crosses the zero line in either direction, it shows a crossing of the two lines. When the histogram reading peaks and turns up or down, indicating that the differential between the lines has run out of momentum and begun to decrease, is an early signal that occurs well before an actual crossing of the lines. My acquaintance used this occurrence as one of the main components of a trading methodology (coupled with ADX readings). I first became aware of the use of the MACD histogram in the late 1980’s, when my friend Alex Elder used and discussed it extensively in a market letter he published at that time. Another reference I highly recommend for discussion of MACD and the Histogram is the relevant section in Elder’s classic “Trading for a Living”, one of the best and most helpful trading books ever written, in my opinion.

Paperback: 45 pages

Publisher: Traders Press, Inc. (2008)

MACD Oscillator and MACD Histogram

The MACD Oscillator is the difference between a short term and a long term moving averages.

The three parameters are the number of periods for the short term moving average, long term moving average and the moving average of the resulting MACD Oscillator.

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This shows the convergence and divergence of the 2 moving averages and is plotted as the red line around the zero point. The MACD is presented with its moving average as the green line. The MACD oscillator is available in the Custom Charts section of our site.

The Exponential MACD Oscillator uses the exponential moving averages in the calculations instead of the regular moving averages.

If you put a zero in the third parameter box, the program will not calculate the moving average of the MACD and only the red line will appear, and the resulting MACD is conventionally presented as a histogram for clarity.

When the MACD Oscillator is above the zero line, conventional wisdom interprets this as a bullish signal, and conversely, when the histogram is below the zero line this is interpreted as a bearish signal. The green line being above the red line reinforces a bullish signal, and the red line below the green line reinforces a bearish signal. Other interpretations use crossovers between the red and green lines as market timing signals if the resulting direction of both lines is the same. Going up is bullish, going down is bearish.

MACD Histogram

This is not the same as the Histogram generated by the MACD Oscillator when the third parameter is set to zero. The MACD Histogram requires all three parameters, set the same way as the MACD study above. It only draws one line, which is presented as a histogram and is the difference between the MACD and it's moving average. It is plotted around the zero point.

When the Histogram is above the zero line, conventional wisdom interprets this as a bullish signal, and conversely, when the histogram is below the zero line this is interpreted as a bearish market.

Description

The Moving Average Convergence Divergence (usually known by the acronym MACD) is a momentum indicator, that was developed by Gerald Appel in the 1960s. The MACD compares two exponential moving averages, and displays the difference between the moving averages as a single line, with positive and negative values, above and below a zero line (an oscillator). The MACD is displayed on its own chart, separate from the price bars, and is the lower section in the example chart (full size chart).

Calculation

Description : The MACD (MACD) is the difference between short term (EMAS) and long term (EMAL) exponential moving averages, and is often used with a signal line that is an exponential moving average of the MACD (EMAMACD).

Calculation :    EMAS = EMASn-1 + ((2 / (n + 1)) * (Pn - EMASn-1))    EMAL = EMALn-1 + ((2 / (n + 1)) * (Pn - EMALn-1))

    MACD = EMAS - EMAL    EMAMACD = EMAMACDn-1 + ((2 / (n + 1)) * (Pn - EMAMACDn-1))

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Trading Use

As the MACD is a momentum indicator, it shows positive momentum when it is above the zero line, and negative momentum when it is below the zero line (similar to the Commodity Channel Index (CCI)). There are many different ways of interpreting the MACD during trading, but the most popular ways (not necessarily the most profitable) include the MACD crossing its signal line and the MACD crossing the zero line. The MACD can also be used as a divergence indicator, with long entries signaled by bullish divergence, and short entries signaled by bearish divergence.

In last week's StreetAuthority Swing Trader we discussed the importance of MACD. You saw that an important component of a successful trading system is to combine weekly and daily MACD signals. You can do so by taking the daily signals that are in accordance with both the weekly MACD and the overall trend (as measured by the 30- or 40-week moving average).

MACD can be made even more useful by incorporating a related indicator -- the MACD histogram. Thomas Aspray described the histogram in 1986. Like MACD, it oscillates around a zero line. But while MACD is an indicator based on moving averages, the

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histogram is an indicator of an indicator -- the MACD itself.

What the histogram shows in graphic form is the difference between the main MACD line (the 12-26 line) and the nine-period trigger line. This difference is then plotted on a scale to form a histogram, defined as a series of vertical lines. The higher the lines "grow" above the histogram's zero line, the stronger the price momentum and the more bullish the trend. The further the lines decline below the zero line, the stronger the negative the trend and the more downside pressure there is. When the MACD indicator itself issues a buy or sell signal, then the histogram is always at its own zero line.

Although you can derive the same information by eyeballing the underlying MACD indicator, the histogram does the job for you, allowing you to spend your full energy on technical analysis.

There are two important ways to use the histogram to generate trading signals. First, the histogram tells you when momentum is beginning to wane. Since a key principle of technical analysis is that momentum precedes price, the histogram gives the technician an early warning that prices may be about to reverse course.

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The chart above is the weekly chart of the S&P 500 index with the 40, 12 and 26-week moving averages shown, as well as MACD and the histogram. First, note that in one year of trading, there have been only three crosses of this histogram above and below the zero line, reflecting the three underlying MACD signals in this time frame. Clearly, these signals are infrequent enough to be carefully noted.

Second, note the negative momentum peak in mid-July and the positive momentum peak in late December. As a trader, one should avoid taking a short position at the peak of negative momentum and a long position at the peak of positive momentum.

The histogram is thus an early warning indicator, telling the trader that a momentum peak has been reached and that a peak in price may not be far away. Given the overall downtrend as measured by the 40-week moving average, going long at the momentum peak would be a serious error and could prove costly.

The histogram also gives important divergence signals. Negative divergence occurs when prices rally to a new high or back to approximately the same level and the histogram is lower. Positive divergence occurs when prices reach a lower low, but the MACD histogram is at a higher level.

The best example of histogram divergence on this chart can be seen when comparing the July and October lows, both of which occurred at around S&P 775. Note that the first low occurred at about –20 on the histogram scale, whereas the second low was very close to the 0 line. The trader who perceived this signal would be on the alert for a price reversal. When the actual MACD crossover occurred in early October, the opportunity could have been acted on without hesitation.

The MACD histogram combines well with MACD to give you a trend-following and momentum indicator all in one. It is an indispensable tool of technical analysis. Next week we will explore the idea of MACD divergence in more detail.

The MACD Histogram gives depth and dimension to what the MACD lines are telling you.

The MACD Histogram measures the difference between the MACD fast line (in red) and the MACD signal line (in blue). If the fast line is above the signal line, the MACD Histogram is positive, and the bars are drawn above the centerline. If the fast line is below the signal line, MACD Histogram is negative, and the bars are drawn below the centerline.

Chrysler Corp (C)

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The MACD Histogram indicator graph is the second from the bottom. The MACD indicator graph is right above that one. The two are used in conjunction with one another.

Do you see that smallish hump above the centerline on Chrysler's MACD Histogram indicator graph that occurs in mid-April? That's a bearish development. Why? Because the hump is smaller than the preceding hump above the centerline, yet prices are higher. In other words, there is a divergence between the events on the price graph and the Histogram. On the price graph we are seeing new highs, yet on the MACD Histogram, quite a small hump is being traced.

Does this mean that mid-April's short green bar is bogus? Not entirely. The green bar was born when there was quite a bit of up volume, as indicated in blue on the Volume graph (which in this case was treacherously deceiving). You simply can't be sure what is going to happen next when dealing with the right edge of any graph, and the bullish green bar above the price graph does terminate correctly after the retracement begins.

When MACD Histogram starts to tick down right after a bullish green bar is born, that's the time to watch carefully and get ready to bail. It means that a new leg on an uptrend might be failing. 

Moving Average Convergence/Divergence (MACD)

Introduction

Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend-following characteristics. These lagging indicators are turned into a momentum oscillator by subtracting the longer moving average

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from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. MACD is a centered oscillator and the guidelines for using centered oscillators apply.

MACD FormulaThe most popular formula for the "standard" MACD is the difference between a security's 26-day and 12-day Exponential Moving Averages (EMAs). This is the formula that is used in many popular technical analysis programs, including SharpCharts, and quoted in most technical analysis books on the subject. Appel and others have since tinkered with these original settings to come up with a MACD that is better suited for faster or slower securities. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator, less prone to whipsaws. For our purposes in this article, the traditional 12/26 MACD will be used for explanations. Later in the indicator series, we will address the use of different moving averages in calculating MACD.Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. Usually, a 9-day EMA of MACD is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above its 9-day EMA, and a bearish crossover occurs when MACD moves below its 9-day EMA. The Merrill Lynch (MER)  chart below shows the 12-day EMA (thin blue line) with the 26-day EMA (thin red line) overlaid the price plot. MACD appears in the box below as the thick black line and its 9-day EMA is the thin blue line. The histogram represents the difference between MACD and its 9-day EMA. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

What Does MACD Do?MACD measures the difference between two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average (blue) and the slower moving average (red) is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.

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This Merrill Lynch (MER)  chart shows MACD as a solid black line, and its 9-day EMA as the thin blue line. Even though moving averages are lagging indicators, notice that MACD moves faster than the moving averages. In this example, MACD provided a few good trading signals as well:

1. In March and April, MACD turned down ahead of both moving averages, and formed a negative divergence ahead of the price peak.

2. In May and June, MACD began to strengthen and make higher Lows while both moving averages continued to make lower Lows.

3. Finally, MACD formed a positive divergence in October while both moving averages recorded new Lows.

MACD Bullish SignalsMACD generates bullish signals from three main sources:

1. Positive Divergence2. Bullish Moving Average Crossover3. Bullish Centerline Crossover

Positive Divergence

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A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher Lows or a second Low that is higher than the previous Low. Positive Divergences are probably the least common of the three signals, but are usually the most reliable, and lead to the biggest moves.

Bullish Moving Average Crossover

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A Bullish Moving Average Crossover occurs when MACD moves above its 9-day EMA, or trigger line. Bullish Moving Average Crossovers are probably the most common signals and as such are the least reliable. If not used in conjunction with other technical analysis tools, these crossovers can lead to whipsaws and many false signals. Bullish Moving Average Crossovers are used occasionally to confirm a positive divergence. A positive divergence can be considered valid when a Bullish Moving Average Crossover occurs after the MACD Line makes its second "higher Low".Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day.

Bullish Centerline Crossover

A Bullish Centerline Crossover occurs when MACD moves above the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive, or from bearish to bullish. After a Positive Divergence and Bullish Centerline Crossover, the Bullish Centerline Crossover can act as a confirmation signal. Of the three signals, moving average crossover are probably the second most common signals.

Using a Combination of Signals

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Even though some traders may use only one of the above signals to form a buy or a sell signal, using a combination can generate more robust signals. In the Halliburton (HAL)  example, all three bullish signals were present and the stock still advanced another 20%. The stock formed a lower Low at the end of February, but MACD formed a higher Low, thus creating a potential Positive Divergence. MACD then formed a Bullish Moving Average Crossover by moving above its 9-day EMA. And finally, MACD traded above zero to form a Bullish Centerline Crossover. At the time of the Bullish Centerline Crossover, the stock was trading at 32 1/4 and went above 40 immediately after that. In August, the stock traded above 50.

Bearish SignalsMACD generates bearish signals from three main sources. These signals are mirror reflections of the bullish signals:

1. Negative Divergence2. Bearish Moving Average Crossover3. Bearish Centerline Crossover

Negative DivergenceA Negative Divergence forms when the security advances or moves sideways, and the MACD declines. The Negative Divergence in MACD can take the form of either a lower High or a straight decline. Negative Divergences are probably the least common of the three signals, but are usually the most reliable, and can warn of an impending peak.

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The FedEx (FDX)  chart shows a Negative Divergence when MACD formed a lower High in May, and the stock formed a higher High at the same time. This was a rather blatant Negative Divergence, and signaled that momentum was slowing. A few days later, the stock broke the uptrend line, and the MACD formed a lower Low.There are two possible means of confirming a Negative Divergence. First, the indicator can form a lower Low. This is traditional peak-and-trough analysis applied to an indicator. With the lower High and subsequent lower Low, the uptrend for MACD has changed from bullish to bearish. Second, a Bearish Moving Average Crossover (which is explained below) can act to confirm a negative divergence. As long as MACD is trading above its 9-day EMA, or trigger line, it has not turned down and the lower High is difficult to confirm. When MACD breaks below its 9-day EMA, it signals that the short-term trend for the indicator is weakening, and a possible interim peak has formed.

Bearish Moving Average CrossoverThe most common signal for MACD is the moving average crossover. A Bearish Moving Average Crossover occurs when MACD declines below its 9-day EMA. Not only are these signals the most common, but they also produce the most false signals. As such, moving average crossovers should be confirmed with other signals to avoid whipsaws and false readings.

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Sometimes a stock can be in a strong uptrend, and MACD will remain above its trigger line for a sustained period of time. In this case, it is unlikely that a Negative Divergence will develop. A different signal is needed to identify a potential change in momentum. This was the case with Merck (MRK)  in February and March. The stock advanced in a strong uptrend, and MACD remained above its 9-day EMA for 7 weeks. When a Bearish Moving Average Crossover occurred, it signaled that upside momentum was slowing. This slowing momentum should have served as an alert to monitor the technical situation for further clues of weakness. Weakness was soon confirmed when the stock broke its uptrend line and MACD continued its decline and moved below zero.

Bearish Centerline CrossoverA Bearish Centerline Crossover occurs when MACD moves below zero and into negative territory. This is a clear indication that momentum has changed from positive to negative, or from bullish to bearish. The centerline crossover can act as an independent signal, or confirm a prior signal such as a moving average crossover or negative divergence. Once MACD crosses into negative territory, momentum, at least for the short term, has turned bearish.

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The significance of the centerline crossover will depend on the previous movements of MACD as well. If MACD is positive for many weeks, begins to trend down, and then crosses into negative territory, it would be bearish. However, if MACD has been negative for a few months, breaks above zero, and then back below, it might be a correction. In order to judge the significance of a centerline crossover, traditional technical analysis can be applied to see if there has been a change in trend, higher High or lower Low.

The Unisys (UIS)  chart depicts a Bearish Centerline Crossover that preceded a 25% drop in the stock that occurs just off the right edge of the chart. Although there was little time to act once this signal appeared, there were other warnings signs prior to the dramatic drop:

1. After the drop to trend line support, a Bearish Moving Average Crossover formed.2. When the stock rebounded from the drop, MACD did not even break above the trigger line, indicating weak

upside momentum.3. The peak of the reaction rally was marked by a shooting star candlestick (blue arrow) and a gap down on

increased volume (red arrows).4. After the gap down, the blue trend line was broken.

In addition to the signals mentioned above, a Bearish Centerline Crossover occurred after MACD had been above zero for almost two months. From 20 Sept on, MACD had been weakening and momentum was slowing. The break below zero acted as the final straw of a long weakening process.

Combining SignalsAs with bullish MACD signals, bearish signals can be combined to create more robust signals. In most cases, stocks fall faster than they rise. This was definitely the case with Unisys (UIS), and only two bearish MACD signals were present. Using momentum indicators like MACD, technical analysis can sometimes provide clues to impending weakness. While it may be impossible to predict the length and duration of the decline, being able to spot weakness can enable traders to take a more defensive position.

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In 2002, Intel (INTC)  dropped from above 36 to below 28 in a few months. Yet it would seem that smart money began distributing the stock before the actual decline. Looking at the technical picture, we can spot evidence of this distribution and a serious loss of momentum:

1. In December, a negative divergence formed in MACD.2. Chaikin Money Flow  turned negative on December 21.3. Also in December, a Bearish Moving Average Crossover occurred in MACD (black arrow).4. The trend line extending up from October was broken on 20 December.5. A Bearish Centerline Crossover occurred in MACD on 10 Feb (green arrow).6. On 15 February, support at 31 1/2 was violated (red arrow).

For those waiting for a recovery in the stock, the continued decline of momentum suggested that selling pressure was increasing, and not about to decrease. Hindsight is 20/20, but with careful study of past situations, we can learn how to better read the present and prepare for the future.

MACD BenefitsOne of the primary benefits of MACD is that it incorporates aspects of both momentum and trend in one indicator. As a trend-following indicator, it will not be wrong for very long. The use of moving averages ensures that the indicator will eventually follow the movements of the underlying security. By usingExponential Moving Averages (EMAs), as opposed to Simple Moving Averages (SMAs), some of the lag has been taken out.As a momentum indicator, MACD has the ability to foreshadow moves in the underlying security. MACD divergences can be key factors in predicting a trend change. A Negative Divergence signals that bullish momentum is waning, and there could be a potential change in trend from bullish to bearish. This can serve as an alert for traders to take some profits in long positions, or for aggressive traders to consider initiating a short position.MACD can be applied to daily, weekly or monthly charts. MACD represents the convergence and divergence of two moving averages. The standard setting for MACD is the difference between the 12 and 26-period EMA. However, any combination of moving averages can be used. The set of moving averages used in MACD can be tailored for each individual security. For weekly charts, a faster set of moving averages may be appropriate. For volatile stocks, slower moving averages may be needed to help smooth the data. Given that level of flexibility, each individual should adjust the MACD to suit his or her own trading style, objectives and risk tolerance.

MACD DrawbacksOne of the beneficial aspects of the MACD is also one of its drawbacks. Moving averages, be they simple, exponential or weighted, are lagging indicators. Even though MACD represents the difference between two moving averages, there can still be some lag in the indicator itself. This is more likely to be the case with weekly charts than daily charts. One solution to this problem is the use of the MACD-Histogram.

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MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to identify levels that historically represent overbought and oversold levels, MACD does not have any upper or lower limits to bind its movement. MACD can continue to overextend beyond historical extremes.

MACD calculates the absolute difference between two moving averages and not the percentage difference. MACD is calculated by subtracting one moving average from the other. As a security increases in price, the difference (both positive and negative) between the two moving averages is destined to grow. This makes its difficult to compare MACD levels over a long period of time, especially for stocks that have grown exponentially.

The Amazon (AMZN)  chart demonstrates the difficult in comparing MACD levels over a long period of time. Before 1999, Amazon's MACD is barely recognizable, and appears to trade close to the zero line. MACD was indeed quite volatile at the time, but this volatility has been dwarfed since the stock rose from below 20 to almost 100.An alternative is to use the Price Oscillator, which shows the percentage difference between two moving averages:

(12 day EMA - 26 day EMA) / (26 day EMA)

(20 - 18) / 18 = .11 or +11%

The resulting percentage difference can be compared over a longer period of time. On the Amazon chart, we can see that the Price Oscillator provides a better means for a long-term comparison. For the short term, MACD and the Price Oscillator are basically the same. The shape of the lines, the divergences, moving average crossovers and centerline crossovers for MACD and the Price Oscillator are virtually identical.

Pros and Cons of the MACDSince Gerald Appel developed the MACD, there have been hundreds of new indicators introduced to technical analysis. While many indicators have come and gone, the MACD has stood the test of time. The concept behind its use is straightforward, and its construction is simple, yet it remains one of the most reliable indicators around. The effectiveness of the MACD will vary for different securities and markets. The lengths of the moving averages can be adapted for a better fit to a particular security or market. As with all indicators , MACD is not infallible and should be used in conjunction with other technical analysis tools.

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MACD-HistogramIn 1986, Thomas Aspray developed the MACD-Histogram. Some of his findings were presented in a series of articles for Technical Analysis of Stocks and Commodities. Aspray noted that MACD's lag would sometimes miss important moves in a security, especially when applied to weekly charts. He first experimented by changing the moving averages and found that shorter moving averages did indeed speed up the signals. However, he was looking for a means to anticipate MACD crossovers. One of the answers he came up with was the MACD-Histogram.

Definition and ConstructionThe MACD-Histogram represents the difference between the MACD and its trigger line, the 9-day EMA of MACD. The plot of this difference is presented as a histogram, making centerline crossovers and divergences easily identifiable. A centerline crossover for the MACD-Histogram is the same as a moving average crossover for MACD. If you will recall, a moving average crossover occurs when MACD moves above or below the trigger line.If the value of MACD is larger than the value of its 9-day EMA, then the value on the MACD-Histogram will be positive. Conversely, if the value of MACD is less than its 9-day EMA, then the value on the MACD-Histogram will be negative.

Further increases or decreases in the gap between MACD and its trigger line will be reflected in the MACD-Histogram. Sharp increases in the MACD-Histogram indicate that MACD is rising faster than its 9-day EMA and bullish momentum is strengthening. Sharp declines in the MACD-Histogram indicate that MACD is falling faster than its 9-day EMA and bearish momentum is increasing.

On the chart above, we can see that the MACD-Histogram movements are relatively independent of the actual MACD. Sometimes the MACD is rising while the MACD-Histogram is falling. At other times, the MACD is falling while the MACD-Histogram is rising. The MACD-Histogram does not reflect the absolute value of the MACD, but rather the value of the

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MACD relative to its 9-day EMA. Usually, but not always, a move in the MACD is preceded by a corresponding divergence in the MACD-Histogram.

1. The first point shows a sharp positive divergence in the MACD-Histogram that preceded a Bullish Moving Average Crossover.

2. On the second point, the MACD continued to new Highs but the MACD-Histogram formed two equal Highs. Although not a textbook case of Positive Divergence, the equal High failed to confirm the strength seen in the MACD.

3. A Positive Divergence formed when the MACD-Histogram formed a higher Low and the MACD continued lower.4. A Negative Divergence formed when the MACD-Histogram formed a lower High and the MACD continued higher.

UsageThomas Aspray designed the MACD-Histogram as a tool to anticipate a moving average crossover in the MACD. Divergences between MACD and the MACD-Histogram are the main tool used to anticipate moving average crossovers. A Positive Divergence in the MACD-Histogram indicates that the MACD is strengthening and could be on the verge of a Bullish Moving Average Crossover. A Negative Divergence in the MACD-Histogram indicates that the MACD is weakening, and it foreshadows a Bearish Moving Average Crossover in the MACD.

In his book, Technical Analysis of the Financial Markets, John Murphy asserts that the best use for the MACD-Histogram is in identifying periods when the gap between the MACD and its 9-day EMA is either widening or shrinking. Broadly speaking, a widening gap indicates strengthening momentum and a shrinking gap indicates weakening momentum. Usually a change in the MACD-Histogram will precede any changes in the MACD.

SignalsThe main signal generated by the MACD-Histogram is a divergence followed by a moving average crossover. A bullish signal is generated when a Positive Divergence forms and there is a Bullish Centerline Crossover. A bearish signal is generated when there is a Negative Divergence and a Bearish Centerline Crossover. Keep in mind that a centerline crossover for the MACD-Histogram represents a moving average crossover for the MACD.Divergences can take many forms and varying degrees. Generally speaking, two types of divergences have been identified: the slant divergence and the peak-trough divergence.

Slant DivergenceA Slant Divergence forms when there is a continuous and relatively smooth move in one direction (up or down) to form the divergence. Slant Divergences generally cover a shorter time frame than divergences formed with two peaks or two troughs. A Slant Divergence can contain some small bumps (peaks or troughs) along the way. The world of technical analysis is not perfect and there are exceptions to most rules and hybrids for many signals.

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Peak-Trough DivergenceA peak-trough divergence occurs when at least two peaks or two troughs develop in one direction to form the divergence. A series of two or more rising troughs (higher lows) can form a Positive Divergence and a series of two or more declining peaks (lower highs) can form a Negative Divergence. Peak-trough Divergences usually cover a longer time frame than slant divergences. On a daily chart, a peak-trough divergence can cover a time frame as short as two weeks or as long as several months.Usually, the longer and sharper the divergence is, the better any ensuing signal will be. Short and shallow divergences can lead to false signals and whipsaws. In addition, it would appear that Peak-trough Divergences are a bit more reliable than Slant Divergences. Peak-trough Divergences tend to be sharper and cover a longer time frame than Slant Divergences.

MACD-Histogram BenefitsThe main benefit of the MACD-Histogram is its ability to anticipate MACD signals. Divergences usually appear in the MACD-Histogram before MACD moving average crossovers do. Armed with this knowledge, traders and investors can better prepare for potential trend changes.

The MACD-Histogram can be applied to daily, weekly or monthly charts. (Note: This may require some tinkering with the number of periods used to form the original MACD; shorter or faster moving averages might be necessary for weekly and monthly charts.) Using weekly charts, the broad underlying trend of a stock can be determined. Once the broad trend has been determined, daily charts can be used to time entry and exit strategies. In Technical Analysis of the Financial Markets, John Murphy advocates this type of two-tiered approach to investing in order to avoid making trades against the major trend. The weekly MACD-Histogram can be used to generate a long-term signal in order to establish the tradable trend. Then only short-term signals that agree with the major trend would be considered.After the trend has been established, MACD-Histogram divergences can be used to signal impending reversals. If the long-term trend was bullish, a negative divergences with bearish centerline crossovers would signal a possible reversal. If the long-term trend was bearish, traders would watch for a positive divergences with bullish centerline crossovers.

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On the IBM  weekly chart, the MACD-Histogram generated four signals. Before each moving average crossover in the MACD, a corresponding divergence formed in the MACD-Histogram. To make adjustments for the weekly chart, the moving averages have been shortened to 6 and 12. This MACD is formed by subtracting the 6-week EMA from the 12-week EMA. A 6-week EMA has been used as the trigger. The MACD-Histogram is calculated by taking the difference between MACD (6/12) and the 6-day EMA of MACD (6/12).

1. The first signal was a Bearish Moving Average Crossover in January, 1999. From its peak in late November, 1998, the MACD-Histogram formed a Negative Divergence that preceded the Bearish Moving Average Crossover in the MACD.

2. The second signal was a Bullish Moving Average Crossover in April. From its low in mid-February, the MACD-Histogram formed a Positive Divergence that preceded the Bullish Moving Average Crossover in the MACD.

3. The third signal was a Bearish Moving Average Crossover in late July. From its May peak, the MACD-Histogram formed a Negative Divergence that preceded a Bearish Moving Average Crossover in the MACD.

4. The final signal was a Bullish Moving Average Crossover, which was preceded by a slight Positive Divergence in the MACD-Histogram.

The third signal was based on a Peak-trough Divergence Two readily identifiable and consecutive lower peaks formed to create the divergence. The peaks and troughs on the previous divergences, although identifiable, do not stand out as much.

MACD-Histogram DrawbacksThe MACD-Histogram is an indicator of an indicator or a derivative of a derivative. The MACD is the first derivative of the price action of a security, and the MACD-Histogram is the second derivative of the price action of a security. As the second derivative, the MACD-Histogram is further removed from the actual price action of the underlying security. The further removed an indicator is from the underlying price action, the greater the chances of false signals. Keep in mind that this is an indicator of an indicator. The MACD-Histogram should not be compared directly with the price action of the underlying security.Because MACD-Histogram was designed to anticipate MACD signals, there is a temptation to jump the gun. The MACD-Histogram should be used in conjunction with other aspects of technical analysis. This will help to alleviate the temptation for early entry. Another means to guard against early entry is to combine weekly signals with daily signals. Of course, there will be more daily signals than weekly signals. However, by using only the daily signals that agree with the weekly signals, there will be fewer daily signals to act on. By acting only on those daily signals that are in agreement with the weekly signals, you are also assured of trading with the longer trend and not against it.

Be careful of small and shallow divergences. While these may sometimes lead to good signals, they are also more apt to create false signals. One method to avoid small divergences is to look for larger divergences with two or more readily identifiable peaks or troughs. Compare the peaks and troughs from past action to determine significance. Only peaks and troughs that appear to be significant should warrant attention.

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MACD HistogramThe MACD Histogram is useful for anticipating changes in trend. 

Overview

The MACD Histogram (MACD-H) consists of vertical bars showing the difference between the MACD

line and its signal line   • A change in the MACD-H will usually precede any changes in MACD

  • Signals are generated by direction, zero line crossovers and divergence from MACD

  • As an indicator of an indicator, MACD-H should be compared with MACD rather than with the price

action of the underlying market.

MACD-H is used with MACD as a complementary indicator. 

Thomas Aspray found that MACD signals often lagged important market moves, especially when applied

to weekly charts. He first experimented with changing the moving averages and found that shorter

moving averages did indeed speed up the signals. However, he was looking for a means to anticipate

MACD crossovers and came up with the MACD Histogram. 

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Interpretation

The MACD Histogram represents the difference between MACD and it's signal line (usually the 9-day

Exponential Moving Average (EMA) of the MACD). Whenever MACD crosses the signal line, MACD-H

crosses the zero line. 

  • If the MACD line is above the signal line, the histogram is positive, and the bars are drawn above the

zero line.

  • If the MACD line is below the signal line, histogram is negative, and the bars are drawn below the zero

line.

Sharp increases in the MACD-H indicate that MACD is rising faster than its 9-day EMA and upward

momentum is strengthening. Sharp declines in the MACD-H indicate that MACD is falling faster than its

moving average and downward momentum is increasing. 

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Divergences between MACD and MACD-H are the main tool used to anticipate crossovers. A positive

divergence in the MACD-H indicates that MACD is strengthening and could be on the verge of a bullish

moving average crossover. A negative divergence in the MACD-H indicates that MACD is weakening

and can act to foreshadow a bearish moving average crossover in MACD. 

Signals

The main signal generated by the MACD-Histogram is a divergence from MACD followed by a zero-line

crossover. 

  • A bullish signal is generated when a positive divergence forms and there is an upward zero line

crossover.

  • A bearish signal is generated when there is a negative divergence and a downward zero line

crossover.

In Technical Analysis of the Financial Markets, John Murphy states that the real value of the MACD-H is

spotting when the spread between the two lines is widening or narrowing. When the histogram is above

its zero line (positive) but starts to fall, the uptrend is weakening. Conversely, when the histogram is

below its zero line (negative) and starts to rise, the downtrend is losing momentum. These turns of the

histogram provide early warnings that the current trend is losing momentum, and the buy or sell signal is

given when the histogram crosses the zero line. 

Murphy also advocates a two-tiered approach in order to avoid making trades against the major trend.

The weekly MACD-H can be used to generate long-term signals. Then only short-term signals that agree

with the major trend are used. 

  • If the long-term trend is up, only positive divergences with upward zero line crossovers are considered

valid for the MACD-H.

  • If the long-term trend is down, only negative divergences with downward zero line crossovers are

considered valid.

Used this way, the weekly signals become trend filters for daily signals. This prevents using daily signals

to trade against the overall trend. 

Information provided by chartfilter.com

The MACD is constructed from two EMAs, or exponential moving averages, derived from the historical price movement of the asset being studied. In a traditional average, all data is treated equally. When calculating an EMA, some data is given a higher weight, or importance, than other data. In the case of MACD, the more recent the data, the more importance it is given. An EMA of six, for example, averages the last six values while giving more weight to the most recent ones.

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MACD subtracts the longer average from the shorter average, and the result is plotted on a chart or graph. MACD typically uses 26- and 12-day EMAs, meaning it looks at the last 26 and 12 days worth of data. The resultant chart oscillates around zero, without preset bounds in either upper or lower directions. In addition to the difference between the averages, MACD values are themselves averaged to produce a center, or trigger line.

MACD attempts to measure both price trend and momentum, where momentum can be thought of as the strength of the trend. If MACD is greater than zero, it means the short-term average is higher than the long-term average, suggesting thefinancial instrument is trending upwards. Similarly, if MACD is less than zero it suggests the instrument is trending downwards. The steeper the slope of the MACD plot, the more violently the price is moving and, therefore, the stronger the momentum.

Bullish and bearish signals can be generated by crossovers or divergences. A divergence occurs when the MACD indicates a move in one direction while the asset price is moving in the other. A crossover is simply the MACD moving over or under the zero (neutral) point, or alternately, crossing its own trigger line. A MACD crossing from positive to negative would be a bearish signal, while a cross from negative to positive is a bullish signal.

MACD Histogram Helps Determine Trend Changesby Investopedia Staff, (Investopedia.com) (Contact Author | Biography)

Here we look at the moving average convergence divergence (MACD) histogram, a measurement of the difference between the fast MACD line and the signal line. (Learn more in A Primer On The MACD.)

Error! Unknown switch argument.The calculation of the signal line requires that you take the difference between the twoEMAs, and from that number create a nine-daymoving average. But sophisticated charting software makes life easy with its back-testing capabilities that automatically prepare all the calculations instantly for the user. In this respect, it is sometimes interesting to know the formula used to derive the number, but never necessary to start calculating the numbers on your own.

PrinciplesHere we look at a number of charts and explain them in detail so that you fully understand this important indicator, and its clear buy and sell signals. First let's highlight the principles of all technical work:

Stock prices tend to move in trends. Volume  is always a strong component with the trends. Trends will tend to continue with strength, once established.

Nortel ExampleThe first chart is that of Nortel Networks, the Canadian tech giant that saw its stock price drop from the C$120

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area to under $9 in a period of 53 weeks. Apart from two very strong sell signals in the summer of 2000, investors paid little attention to these strong overbought points and continued to trade into the "street" hype that was the norm surrounding so many of the tech/internet issues of that period. 

Since the early part of Sept 2000, the downtrend that was then established remained intact. Now, having said that, there were buyers from those lofty levels all the way down to its single-digit trading price: why would a broker or financial advisor put a client back into an issue that displays nothing but heavy selling to the downside? 

You can see by the trendline drawn on the chart, there was no change in the trend since Aug 2000, and look closely at the diminished volume over the last four months or so shown on the chart. At the same time the moving averages of the MACD were hugging the signal line, showing no clear buy or sell signal at all. 

Figure 1: Nortel Example ChartCreated Using TradeStation 2000

At that time, comments made by company CEO John Roth had indicated that the company would find itself in a rebuilding mode until late 2002 and perhaps even into the early part of 2003. Now from a fundamental standpoint, the technician would have stayed away from this chart because a sideways trading pattern would start to develop once a bottom was established, and in the case of Nortel Networks, the bottom was imminent. (Learn more about using MACD in Spotting Trend Reversals With MACD.)

Cisco ExampleIn the second chart, that of Cisco Systems, two very clear sell signals were indicated. The first, in Dec 2000 from the $55 level saw the stock price drop off dramatically to about the $35 level in a matter of a few trading days and then another sell signal triggered another series of down days seeing the issue drop to the mid-teens in a period of two months. Since then, you could see that the company traded in a somewhat narrow range (sideways movement) and the two EMAs that made up the MACD were hugging the signal line. This is a "wait-and-see" pattern. Take a good look at the trendline, showing the downtrend in volume during this period of sideways trading. No interest, no volume. 

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Created by TradeStation 2000

Conclusion

MACD helps you to determine changes in trends, either short-term or the long-term variety. Learn to

recognize them and do not bet against them. (For more, check out Moving Average MACD

Combo and Trading The MACD Divergence.) 

In last week's StreetAuthority Swing Trader we discussed the importance of MACD. You saw that an important component of a successful trading system is to combine weekly and daily MACD signals. You can do so by taking the daily signals that are in accordance with both the weekly MACD and the overall trend (as measured by the 30- or 40-week moving average).

MACD can be made even more useful by incorporating a related indicator -- the MACD histogram. Thomas Aspray described the histogram in 1986. Like MACD, it oscillates around a zero line. But while MACD is an indicator based on moving averages, the

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histogram is an indicator of an indicator -- the MACD itself.

What the histogram shows in graphic form is the difference between the main MACD line (the 12-26 line) and the nine-period trigger line. This difference is then plotted on a scale to form a histogram, defined as a series of vertical lines. The higher the lines "grow" above the histogram's zero line, the stronger the price momentum and the more bullish the trend. The further the lines decline below the zero line, the stronger the negative the trend and the more downside pressure there is. When the MACD indicator itself issues a buy or sell signal, then the histogram is always at its own zero line.

Although you can derive the same information by eyeballing the underlying MACD indicator, the histogram does the job for you, allowing you to spend your full energy on technical analysis.

There are two important ways to use the histogram to generate trading signals. First, the histogram tells you when momentum is beginning to wane. Since a key principle of technical analysis is that momentum precedes price, the histogram gives the technician an early warning that prices may be about to reverse course.

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The chart above is the weekly chart of the S&P 500 index with the 40, 12 and 26-week moving averages shown, as well as MACD and the histogram. First, note that in one year of trading, there have been only three crosses of this histogram above and below the zero line, reflecting the three underlying MACD signals in this time frame. Clearly, these signals are infrequent enough to be carefully noted.

Second, note the negative momentum peak in mid-July and the positive momentum peak in late December. As a trader, one should avoid taking a short position at the peak of negative momentum and a long position at the peak of positive momentum.

The histogram is thus an early warning indicator, telling the trader that a momentum peak has been reached and that a peak in price may not be far away. Given the overall downtrend as measured by the 40-week moving average, going long at the momentum peak would be a serious error and could prove costly.

The histogram also gives important divergence signals. Negative divergence occurs when prices rally to a new high or back to approximately the same level and the histogram is lower. Positive divergence occurs when prices reach a lower low, but the MACD histogram is at a higher level.

The best example of histogram divergence on this chart can be seen when comparing the July and October lows, both of which occurred at around S&P 775. Note that the first low occurred at about –20 on the histogram scale, whereas the second low was very close to the 0 line. The trader who perceived this signal would be on the alert for a price reversal. When the actual MACD crossover occurred in early October, the opportunity could have been acted on without hesitation.

The MACD histogram combines well with MACD to give you a trend-following and momentum indicator all in one. It is an indispensable tool of technical analysis. Next week we will explore the idea of MACD divergence in more detail.

Learn How to Apply MACD to Your Trading - Part 1By Gerald Appel AND Marvin Appel | TradingMarkets.com

The Moving Average Convergence - Divergence Indicator (MACD) has been a staple of technical   analysis  since Gerald invented it more than 30 years ago. We speculate that part of the reason why MACD has become so popular is its versatility: you can use it as an indicator with which to recognize and follow strong trends, and also as a tool for recognizing trendreversals.

In this article, we will discuss how to calculate the MACD and some basic ways to interpret it.

How to calculate MACDThe heart of the MACD is the difference between two moving   averages : a faster one (reflecting shorter term market trends) minus a slower one (reflecting longer term trends).

We frequently utilize two different sets of moving averages to calculate MACDs: a 12-day exponential moving average as the faster one paired with a 26-day exponential moving average for the slower one, or a 19-day exponential moving average paired with a 39-day average.

For example, the 12-26 day MACD is calculated each day as: 12-day exponential moving average minus 26-day exponential moving average.

This begs the question of how to calculate N-day exponential moving averages (here, N is 12 or 26), which we will now briefly review:

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First, find the smoothing constant 2/(N+1). In the case of the 12-day exponential moving average, the smoothing constant would be 2/(12+1) = 2/13 = 0.154. In the case of the 27-day exponential moving average, the smoothing constant would be 2/(26+1) = 2/27 = 0.074.

For brevity, let's call exponential moving averages by a shorter name, "expo". Having calculated the smoothing constants we use them to update the exponential moving averages for each new piece of data as follows:

For brevity, let's call exponential moving averages by a shorter name, "expo". Having calculated the smoothing constants we use them to update the exponential moving averages for each new piece of data as follows:

Here is an example of the numerical calculations. Suppose that yesterday, the price was 265, the 12-day expo was 266 and the 26-day expo was 263.

Yesterday's MACD would therefore have been 12-day expo minus 26 day expo = 266-263 = 3. Now suppose that today's closing   price  rose to 270.

One last detail: These formulas are recursive, which means that today's reading depends on yesterday's, which does not tell you where to start. A simple approximation is to use the earliest price you have as the earliest exponential moving average reading. Following this procedure introduces a small error, but after a few weeks of data that error becomes negligible.

Basic patterns

Two of the most important features of the MACD are whether it is above or below zero, and whether it is rising or falling.

As a general rule of thumb, the market climate is most unfavorable when MACD is falling and below zero.

This signifies that shorter term market   trends  are weaker than longer term trends. This is not to imply that every day on which MACD is falling and below zero is necessarily going to be a losing day. However, in our experience, this rule of thumb has correctly identified shorter and longer market corrections.

When you study how MACD works with the vehicles you like to trade, it is vitally important to keep in mind that you cannot act on an MACD reading until the day after the data are in.

You can use this information only for the next day. (Here we assume daily MACDs, but you could apply the same techniques to intra-day data such as 60-minute bars, or to weekly data.)

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For example, if we say that periods when the MACD are falling and below zero are unfavorable, we really mean that the days following MACD readings that are falling and below zero have been worse than average.

Let's see this in action.

Example: Dow-Jones AIG Energy Index

There are two reasons to study this particular index.

1. Given the surge in oil   prices  to record highs, energy has become a hot topic.2. There exist exchange-traded notes (similar to ETFs) that track this specific index. Although past results never guarantee what will happen to an investment in the future, we consider it an advantage to trade an investment that has extensive real time history or that tracks an index with an extensive history.

Daily data on the DJ-AIG Energy Index is available back to 1991.

Figure 1 below shows seventeen years of history for the DJ-AIG Energy Index (1991-2008). The gray part of the price chart represents days immediately following MACD readings below zero. The black part of the price chart represents days immediately following MACD readings above zero. Notice that all the major corrections were characterized by MACD less than 0, and the major uptrends by MACD greater than 0.

Figure 1: Dow Jones-AIG Energy Index, 1991-2008 in two colors: Gray when MACD was below zero the day before, and black when MACD was above zero the day before.

Analysis of the daily price and MACD data revealed that on days following when the 19-39 day MACD was greater than zero, the DJ-AIG Energy Index rose at a rate of 14%/year while invested. This favorable condition was in effect 55% of the time. On the other hand, on days following MACD readings below zero, this energy index fell at an annualized rate of 2%/year.

Even worse, days following MACD readings that were falling and below zero saw an annualized loss rate of 11%/year. This bearish condition was in effect 22% of the time. During the entire period, the index gained 6.1%/year. It does appear that the 19-39 day MACD did an excellent job discriminating between bullish and bearish conditions in the energy market.

Conclusion

We have seen how to calculate the MACD, although many of you may be using software packages that do this for you.

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The first bits of information to glean are whether the MACD is above or below zero, and whether it is rising or falling. Generally, market conditions are unfavorable when the MACD is falling and below zero.

Next we saw that by converting MACD from units of price (or points) to units of %, it is possible to compare market conditions from periods when prices varied widely. In the case of the Dow Jones Industrial Average, we saw that -3% has historically been a long-term oversold level for the 12-26 week MACD%, and frequently a prelude to excellent market entries.

We cannot emphasize enough that you need to experiment with whatever vehicle you are trading to determine whether the MACD patterns presented here might also be relevant to your own investment, because that will often not be the case.

Also, you should take potential transaction costs into account when deciding how you might want to apply the MACD to your own investing strategies.

The concepts discussed here are covered in more detail in Gerald Appel's book, "Technical Analysis: Power Tools for Active Investors" (2005).

In the second part of this series Gerald and Marvin Appel will show you how MACD can be used as an indicator of the overall investment climate.

Gerald Appel is the President of Signalert Corporation of Great Neck, New York, an SEC-registered investment advisory firm. He is the inventor of the MACD and the author of a number of groundbreaking investment books, the most recent of which is Beating the Market Three Months at a Time (2008), which he co-authored with Marvin Appel.

Marvin Appel is the CEO of Appel Asset   Management  Corporation, also an SEC-registered investment advisory firm in Great Neck. He is a renowned expert in exchange-traded funds and the editor of the well-regarded investment newsletter Systems and Forecasts. For more information about the material discussed in this article, please visit www.systemsandforecasts.com.

>> See more articles by Gerald Appel AND Marvin Appel

 

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Moving Average Convergence/Divergence (MACD)

MACD FormulaThe most popular formula for the "standard" MACD is the difference between a security's 26-day and 12-day Exponential Moving Averages (EMAs). This is the formula that is used in many popular technical analysis programs, including SharpCharts, and quoted in most technical analysis books on the subject. Appel and others have since tinkered with these original settings to come up with a MACD that is better suited for faster or slower securities. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator, less prone to whipsaws. For our purposes in this article, the traditional 12/26 MACD will be used for explanations. Later in the indicator series, we will address the use of different moving averages in calculating MACD.Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. Usually, a 9-day EMA of MACD is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above its 9-day EMA, and a bearish crossover occurs when MACD moves

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below its 9-day EMA. The Merrill Lynch (MER)  chart below shows the 12-day EMA (thin blue line) with the 26-day EMA (thin red line) overlaid the price plot. MACD appears in the box below as the thick black line and its 9-day EMA is the thin blue line. The histogram represents the difference between MACD and its 9-day EMA. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

What Does MACD Do?MACD measures the difference between two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average (blue) and the slower moving average (red) is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.

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This Merrill Lynch (MER)  chart shows MACD as a solid black line, and its 9-day EMA as the thin blue line. Even though moving averages are lagging indicators, notice that MACD moves faster than the moving averages. In this example, MACD provided a few good trading signals as well:

1. In March and April, MACD turned down ahead of both moving averages, and formed a negative divergence ahead of the price peak.

2. In May and June, MACD began to strengthen and make higher Lows while both moving averages continued to make lower Lows.

3. Finally, MACD formed a positive divergence in October while both moving averages recorded new Lows.

MACD Bullish SignalsMACD generates bullish signals from three main sources:

1. Positive Divergence2. Bullish Moving Average Crossover3. Bullish Centerline Crossover

Positive Divergence

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A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher Lows or a second Low that is higher than the previous Low. Positive Divergences are probably the least common of the three signals, but are usually the most reliable, and lead to the biggest moves.

Bullish Moving Average Crossover

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A Bullish Moving Average Crossover occurs when MACD moves above its 9-day EMA, or trigger line. Bullish Moving Average Crossovers are probably the most common signals and as such are the least reliable. If not used in conjunction with other technical analysis tools, these crossovers can lead to whipsaws and many false signals. Bullish Moving Average Crossovers are used occasionally to confirm a positive divergence. A positive divergence can be considered valid when a Bullish Moving Average Crossover occurs after the MACD Line makes its second "higher Low".Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day.

Bullish Centerline Crossover

A Bullish Centerline Crossover occurs when MACD moves above the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive, or from bearish to bullish. After a Positive Divergence and Bullish Centerline Crossover, the Bullish Centerline Crossover can act as a confirmation signal. Of the three signals, moving average crossover are probably the second most common signals.

Using a Combination of Signals

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Even though some traders may use only one of the above signals to form a buy or a sell signal, using a combination can generate more robust signals. In the Halliburton (HAL)  example, all three bullish signals were present and the stock still advanced another 20%. The stock formed a lower Low at the end of February, but MACD formed a higher Low, thus creating a potential Positive Divergence. MACD then formed a Bullish Moving Average Crossover by moving above its 9-day EMA. And finally, MACD traded above zero to form a Bullish Centerline Crossover. At the time of the Bullish Centerline Crossover, the stock was trading at 32 1/4 and went above 40 immediately after that. In August, the stock traded above 50.

MACD FormulaThe most popular formula for the "standard" MACD is the difference between a security's 26-day and 12-day Exponential Moving Averages (EMAs). This is the formula that is used in many popular technical analysis programs, including SharpCharts, and quoted in most technical analysis books on the subject. Appel and others have since tinkered with these original settings to come up with a MACD that is better suited for faster or slower securities. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator, less prone to whipsaws. For our purposes in this article, the traditional 12/26 MACD will be used for explanations. Later in the indicator series, we will address the use of different moving averages in calculating MACD.Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. Usually, a 9-day EMA of MACD is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above its 9-day EMA, and a bearish crossover occurs when MACD moves below its 9-day EMA. The Merrill Lynch (MER)  chart below shows the 12-day EMA (thin blue line) with the 26-day EMA (thin red line) overlaid the price plot. MACD appears in the box below as the thick black line and its 9-day EMA is the thin blue line. The histogram represents the difference between MACD and its 9-day EMA. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

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What Does MACD Do?MACD measures the difference between two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average (blue) and the slower moving average (red) is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.

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This Merrill Lynch (MER)  chart shows MACD as a solid black line, and its 9-day EMA as the thin blue line. Even though moving averages are lagging indicators, notice that MACD moves faster than the moving averages. In this example, MACD provided a few good trading signals as well:

1. In March and April, MACD turned down ahead of both moving averages, and formed a negative divergence ahead of the price peak.

2. In May and June, MACD began to strengthen and make higher Lows while both moving averages continued to make lower Lows.

3. Finally, MACD formed a positive divergence in October while both moving averages recorded new Lows.

MACD Bullish SignalsMACD generates bullish signals from three main sources:

1. Positive Divergence2. Bullish Moving Average Crossover3. Bullish Centerline Crossover

Positive Divergence

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A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher Lows or a second Low that is higher than the previous Low. Positive Divergences are probably the least common of the three signals, but are usually the most reliable, and lead to the biggest moves.

Bullish Moving Average Crossover

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A Bullish Moving Average Crossover occurs when MACD moves above its 9-day EMA, or trigger line. Bullish Moving Average Crossovers are probably the most common signals and as such are the least reliable. If not used in conjunction with other technical analysis tools, these crossovers can lead to whipsaws and many false signals. Bullish Moving Average Crossovers are used occasionally to confirm a positive divergence. A positive divergence can be considered valid when a Bullish Moving Average Crossover occurs after the MACD Line makes its second "higher Low".Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day.

Bullish Centerline Crossover

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A Bullish Centerline Crossover occurs when MACD moves above the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive, or from bearish to bullish. After a Positive Divergence and Bullish Centerline Crossover, the Bullish Centerline Crossover can act as a confirmation signal. Of the three signals, moving average crossover are probably the second most common signals.

Using a Combination of Signals

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Even though some traders may use only one of the above signals to form a buy or a sell signal, using a combination can generate more robust signals. In the Halliburton (HAL)  example, all three bullish signals were present and the stock still advanced another 20%. The stock formed a lower Low at the end of February, but MACD formed a higher Low, thus creating a potential Positive Divergence. MACD then formed a Bullish Moving Average Crossover by moving above its 9-day EMA. And finally, MACD traded above zero to form a Bullish Centerline Crossover. At the time of the Bullish Centerline Crossover, the stock was trading at 32 1/4 and went above 40 immediately after that. In August, the stock traded above 50.

MACD BenefitsOne of the primary benefits of MACD is that it incorporates aspects of both momentum and trend in one indicator. As a trend-following indicator, it will not be wrong for very long. The use of moving averages ensures that the indicator will eventually follow the movements of the underlying security. By usingExponential Moving Averages (EMAs), as opposed to Simple Moving Averages (SMAs), some of the lag has been taken out.As a momentum indicator, MACD has the ability to foreshadow moves in the underlying security. MACD divergences can be key factors in predicting a trend change. A Negative Divergence signals that bullish momentum is waning, and there could be a potential change in trend from bullish to bearish. This can serve as an alert for traders to take some profits in long positions, or for aggressive traders to consider initiating a short position.MACD can be applied to daily, weekly or monthly charts. MACD represents the convergence and divergence of two moving averages. The standard setting for MACD is the difference between the 12 and 26-period EMA. However, any combination of moving averages can be used. The set of moving averages used in MACD can be tailored for each individual security. For weekly charts, a faster set of moving averages may be appropriate. For volatile stocks, slower moving averages may be needed to help smooth the data. Given that level of flexibility, each individual should adjust the MACD to suit his or her own trading style, objectives and risk tolerance.

MACD DrawbacksOne of the beneficial aspects of the MACD is also one of its drawbacks. Moving averages, be they simple, exponential or weighted, are lagging indicators. Even though MACD represents the difference between two moving averages, there can still be some lag in the indicator itself. This is more likely to be the case with weekly charts than daily charts. One solution to this problem is the use of the MACD-Histogram.MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to identify levels that historically represent overbought and oversold levels, MACD does not have any upper or lower limits to bind its movement. MACD can continue to overextend beyond historical extremes.

MACD calculates the absolute difference between two moving averages and not the percentage difference. MACD is calculated by subtracting one moving average from the other. As a security increases in price, the difference (both positive and negative) between the two moving averages is destined to grow. This makes its difficult to compare MACD levels over a long period of time, especially for stocks that have grown exponentially.

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The Amazon (AMZN)  chart demonstrates the difficult in comparing MACD levels over a long period of time. Before 1999, Amazon's MACD is barely recognizable, and appears to trade close to the zero line. MACD was indeed quite volatile at the time, but this volatility has been dwarfed since the stock rose from below 20 to almost 100.An alternative is to use the Price Oscillator, which shows the percentage difference between two moving averages:

(12 day EMA - 26 day EMA) / (26 day EMA)

(20 - 18) / 18 = .11 or +11%

The resulting percentage difference can be compared over a longer period of time. On the Amazon chart, we can see that the Price Oscillator provides a better means for a long-term comparison. For the short term, MACD and the Price Oscillator are basically the same. The shape of the lines, the divergences, moving average crossovers and centerline crossovers for MACD and the Price Oscillator are virtually identical.

Pros and Cons of the MACDSince Gerald Appel developed the MACD, there have been hundreds of new indicators introduced to technical analysis. While many indicators have come and gone, the MACD has stood the test of time. The concept behind its use is straightforward, and its construction is simple, yet it remains one of the most reliable indicators around. The effectiveness of the MACD will vary for different securities and markets. The lengths of the moving averages can be adapted for a better fit to a particular security or market. As with all indicators , MACD is not infallible and should be used in conjunction with other technical analysis tools.

MACD-HistogramIn 1986, Thomas Aspray developed the MACD-Histogram. Some of his findings were presented in a series of articles for Technical Analysis of Stocks and Commodities. Aspray noted that MACD's lag would sometimes miss important moves in a security, especially when applied to weekly charts. He first experimented by changing the moving averages and found that shorter moving averages did indeed speed up the signals. However, he was looking for a means to anticipate MACD crossovers. One of the answers he came up with was the MACD-Histogram.

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Definition and ConstructionThe MACD-Histogram represents the difference between the MACD and its trigger line, the 9-day EMA of MACD. The plot of this difference is presented as a histogram, making centerline crossovers and divergences easily identifiable. A centerline crossover for the MACD-Histogram is the same as a moving average crossover for MACD. If you will recall, a moving average crossover occurs when MACD moves above or below the trigger line.If the value of MACD is larger than the value of its 9-day EMA, then the value on the MACD-Histogram will be positive. Conversely, if the value of MACD is less than its 9-day EMA, then the value on the MACD-Histogram will be negative.

Further increases or decreases in the gap between MACD and its trigger line will be reflected in the MACD-Histogram. Sharp increases in the MACD-Histogram indicate that MACD is rising faster than its 9-day EMA and bullish momentum is strengthening. Sharp declines in the MACD-Histogram indicate that MACD is falling faster than its 9-day EMA and bearish momentum is increasing.

On the chart above, we can see that the MACD-Histogram movements are relatively independent of the actual MACD. Sometimes the MACD is rising while the MACD-Histogram is falling. At other times, the MACD is falling while the MACD-Histogram is rising. The MACD-Histogram does not reflect the absolute value of the MACD, but rather the value of the MACD relative to its 9-day EMA. Usually, but not always, a move in the MACD is preceded by a corresponding divergence in the MACD-Histogram.

1. The first point shows a sharp positive divergence in the MACD-Histogram that preceded a Bullish Moving Average Crossover.

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2. On the second point, the MACD continued to new Highs but the MACD-Histogram formed two equal Highs. Although not a textbook case of Positive Divergence, the equal High failed to confirm the strength seen in the MACD.

3. A Positive Divergence formed when the MACD-Histogram formed a higher Low and the MACD continued lower.4. A Negative Divergence formed when the MACD-Histogram formed a lower High and the MACD continued higher.

UsageThomas Aspray designed the MACD-Histogram as a tool to anticipate a moving average crossover in the MACD. Divergences between MACD and the MACD-Histogram are the main tool used to anticipate moving average crossovers. A Positive Divergence in the MACD-Histogram indicates that the MACD is strengthening and could be on the verge of a Bullish Moving Average Crossover. A Negative Divergence in the MACD-Histogram indicates that the MACD is weakening, and it foreshadows a Bearish Moving Average Crossover in the MACD.

In his book, Technical Analysis of the Financial Markets, John Murphy asserts that the best use for the MACD-Histogram is in identifying periods when the gap between the MACD and its 9-day EMA is either widening or shrinking. Broadly speaking, a widening gap indicates strengthening momentum and a shrinking gap indicates weakening momentum. Usually a change in the MACD-Histogram will precede any changes in the MACD.

SignalsThe main signal generated by the MACD-Histogram is a divergence followed by a moving average crossover. A bullish signal is generated when a Positive Divergence forms and there is a Bullish Centerline Crossover. A bearish signal is generated when there is a Negative Divergence and a Bearish Centerline Crossover. Keep in mind that a centerline crossover for the MACD-Histogram represents a moving average crossover for the MACD.Divergences can take many forms and varying degrees. Generally speaking, two types of divergences have been identified: the slant divergence and the peak-trough divergence.

Slant DivergenceA Slant Divergence forms when there is a continuous and relatively smooth move in one direction (up or down) to form the divergence. Slant Divergences generally cover a shorter time frame than divergences formed with two peaks or two troughs. A Slant Divergence can contain some small bumps (peaks or troughs) along the way. The world of technical analysis is not perfect and there are exceptions to most rules and hybrids for many signals.

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Peak-Trough DivergenceA peak-trough divergence occurs when at least two peaks or two troughs develop in one direction to form the divergence. A series of two or more rising troughs (higher lows) can form a Positive Divergence and a series of two or more declining peaks (lower highs) can form a Negative Divergence. Peak-trough Divergences usually cover a longer time frame than slant divergences. On a daily chart, a peak-trough divergence can cover a time frame as short as two weeks or as long as several months.Usually, the longer and sharper the divergence is, the better any ensuing signal will be. Short and shallow divergences can lead to false signals and whipsaws. In addition, it would appear that Peak-trough Divergences are a bit more reliable than Slant Divergences. Peak-trough Divergences tend to be sharper and cover a longer time frame than Slant Divergences.

MACD-Histogram BenefitsThe main benefit of the MACD-Histogram is its ability to anticipate MACD signals. Divergences usually appear in the MACD-Histogram before MACD moving average crossovers do. Armed with this knowledge, traders and investors can better prepare for potential trend changes.

The MACD-Histogram can be applied to daily, weekly or monthly charts. (Note: This may require some tinkering with the number of periods used to form the original MACD; shorter or faster moving averages might be necessary for weekly and monthly charts.) Using weekly charts, the broad underlying trend of a stock can be determined. Once the broad trend has been determined, daily charts can be used to time entry and exit strategies. In Technical Analysis of the Financial Markets, John Murphy advocates this type of two-tiered approach to investing in order to avoid making trades against the major trend. The weekly MACD-Histogram can be used to generate a long-term signal in order to establish the tradable trend. Then only short-term signals that agree with the major trend would be considered.After the trend has been established, MACD-Histogram divergences can be used to signal impending reversals. If the long-term trend was bullish, a negative divergences with bearish centerline crossovers would signal a possible reversal. If the long-term trend was bearish, traders would watch for a positive divergences with bullish centerline crossovers.

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On the IBM  weekly chart, the MACD-Histogram generated four signals. Before each moving average crossover in the MACD, a corresponding divergence formed in the MACD-Histogram. To make adjustments for the weekly chart, the moving averages have been shortened to 6 and 12. This MACD is formed by subtracting the 6-week EMA from the 12-week EMA. A 6-week EMA has been used as the trigger. The MACD-Histogram is calculated by taking the difference between MACD (6/12) and the 6-day EMA of MACD (6/12).

1. The first signal was a Bearish Moving Average Crossover in January, 1999. From its peak in late November, 1998, the MACD-Histogram formed a Negative Divergence that preceded the Bearish Moving Average Crossover in the MACD.

2. The second signal was a Bullish Moving Average Crossover in April. From its low in mid-February, the MACD-Histogram formed a Positive Divergence that preceded the Bullish Moving Average Crossover in the MACD.

3. The third signal was a Bearish Moving Average Crossover in late July. From its May peak, the MACD-Histogram formed a Negative Divergence that preceded a Bearish Moving Average Crossover in the MACD.

4. The final signal was a Bullish Moving Average Crossover, which was preceded by a slight Positive Divergence in the MACD-Histogram.

The third signal was based on a Peak-trough Divergence Two readily identifiable and consecutive lower peaks formed to create the divergence. The peaks and troughs on the previous divergences, although identifiable, do not stand out as much.

MACD-Histogram DrawbacksThe MACD-Histogram is an indicator of an indicator or a derivative of a derivative. The MACD is the first derivative of the price action of a security, and the MACD-Histogram is the second derivative of the price action of a security. As the second derivative, the MACD-Histogram is further removed from the actual price action of the underlying security. The further removed an indicator is from the underlying price action, the greater the chances of false signals. Keep in mind that this is an indicator of an indicator. The MACD-Histogram should not be compared directly with the price action of the underlying security.Because MACD-Histogram was designed to anticipate MACD signals, there is a temptation to jump the gun. The MACD-Histogram should be used in conjunction with other aspects of technical analysis. This will help to alleviate the temptation for early entry. Another means to guard against early entry is to combine weekly signals with daily signals. Of course, there will be more daily signals than weekly signals. However, by using only the daily signals that agree with the weekly signals, there will be fewer daily signals to act on. By acting only on those daily signals that are in agreement with the weekly signals, you are also assured of trading with the longer trend and not against it.

Be careful of small and shallow divergences. While these may sometimes lead to good signals, they are also more apt to create false signals. One method to avoid small divergences is to look for larger divergences with two or more readily identifiable peaks or troughs. Compare the peaks and troughs from past action to determine significance. Only peaks and troughs that appear to be significant should warrant attention.

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Learn How to Apply MACD to Your Trading - Part IIBy Gerald Appel AND Marvin Appel 

A Refinement: Using MACD to Find Overbought/oversold areas

You are not limited to checking whether MACD is above or below zero - the actual level can be important as well, particularly at historical extremes. For example, if you calculate that MACD has gotten unusually far below zero, down to areas seen only at previous major market bottoms, it would be reasonable to use that observation as the basis for predicting that the market was due to turn back up.

We will see how that has worked with the Dow Jones Industrial Average, but first we need to digress to cover one more fine point.

When analyzing multi-year charts, prices can cover a very wide range. For example, if you use the formulas presented so far on a long-term chart of the Dow Industrials, you might get a result like what appears in Figure 2:

Figure 2: Dow   Jones   Industrial   Average  weekly, and three market declines, 1970-2008, along with the 12-26 week MACD expressed in points.The three events shown in Figure 2 are the 1973-1974 bear   market , the stock market crash of October 1987, and the recent (October 2007-March 2008) market correction. The worst extent of the price declines (based on weekly closes) is labeled.

Clearly, in terms of price decline, the recent correction is far milder than the other two historical events.

However, the decline in MACD was far more dramatic in 2008 than in 1987 or 1974. The reason is that themoving   average  formulas use price data, so a 100-point decline in the Dow Industrials can produce roughly the same point change in an exponential moving average regardless of whether the starting price is 1000 or 10,000.What matters is not the general level of stock prices, but only the number of points that separate the stock price and its moving average. However, as equity   investors , we are usually more interested in percentagechanges than in point changes. (Futures traders may not agree.)

Fortunately, a simple additional calculation can create a MACD that reflects percentage changes so that the market action that occurred in disparate price ranges can be compared.

In order to normalize MACD, simply divide the original reading by the slower moving average.

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In order to avoid confusion between the two different formulas, we will refer to the MACD in % calculated by equation 2 as "MACD%". If we utilize the formula for MACD% on the price history in Figure 2, we get the more consistent result that appears in Figure 3, where the magnitude of the moves in MACD% parallels thepercentage changes in price.

Signals that have been correct 85% of the time

Now that we are in a position to compare MACD% readings from the 1970s (when the Dow Industrials peaked around 1000) and the current decade (where the Dow peaked at 14,000) we can see that the 12-26 week MACD% reached a major long-term oversold level when it got down to -3% or below.

That has only occurred seven times in the past 38 years. When MACD subsequently climbed back above -3%, it was a good time to enter the market on all but one of these occasions (November 2001).

The market correction that has carried into 2008 has not brought the 12-26 week MACD% of the Dow Industrials down as far as -3%. If it does, we would consider the subsequent recovery to be a good time to take new positions.

Figure 3: Dow   Jones   Industrial   Average  (1970-2008) with the 12-26 week MACD expressed as %. Vertical dashed lines indicate the seven occasions when MACD% climbed from below to above -3%. The 1973-1974 bear market, crash of 1987 and 2007-2008 market correction are labeled A,B,C (respectively) as in Figure 2.The concepts discussed here are covered in more detail in Gerald Appel's book, "Technical   Analysis : Power Tools for Active Investors" (2005).Gerald Appel is the President of Signalert Corporation of Great Neck, New York, an SEC-registered investment advisory firm. He is the inventor of the MACD and the author of a number of groundbreakinginvestment books, the most recent of which is Beating the Market Three Months at a Time (2008), which he co-authored with Marvin Appel.Marvin Appel is the CEO of Appel Asset   Management  Corporation, also an SEC-registered investment advisory firm in Great Neck. He is a renowned expert in exchange-traded funds and the editor of the well-regarded investment newsletter Systems and Forecasts. For more information about the material discussed in this article, please visit www.systemsandforecasts.com.

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MACD HistogramMACD

1. MACD Defined 2. Moving Average Crossovers 3. MACD Histograms4. MACD Divergences

The MACD Histogram is simply the difference between the MACD line (blue line) and the MACD signal line (red line). The MACD histogram is illustrated in the chart below of the Nasdaq 100 QQQQ's:

Two important terms are derived from the MACD histogram and are illustrated above in the chart of the QQQQ's:

Convergence: The MACD histogram is shrinking in height. This occurs because there is a change in direction or a slowdown in the stock, future, bond, or currency trend. When that occurs, the MACD line is getting closer to the MACD signal line.

Divergence: The MACD histogram is increasing in height (either in the positive or negative direction). This occurs because the MACD is accelerating faster in the direction of the prevailing market trend.

When a stock, future, or currency pair is moving strongly in a direction, the MACD histogram will increase in height. When the MACD histogram does not increase in height or begins to shrink, the market is slowing down and is a warning of a possible reversal. The graph below of the E-mini Nasdaq 100 Index Future shows this phenomenon:

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The letter "T" represents when the top or peak of the MACD histogram occurs. In contrast, the letter "B" shows when the bottom of the MACD histogram occurs. Notice how closely the tops and bottoms of the MACD histogram are to the tops of the Nasdaq 100 e-mini future.

MACD Histogram Buy SignalWhen the MACD histogram is below the zero line and begins to converge towards the zero line.

MACD Histogram Sell SignalWhen the MACD histogram is above the zero line and begins to converge towards the zero line.

Note: In the example above, three consecutive days of shrinking MACD histogram from top or bottom served as the buy or sell signals shown with arrows. This is an agressive example. One could wait until the MACD histogram went to zero, but that would be the same signal as the MACD moving average crossover.

The MACD is not only good for buy and sell signals, the MACD can be used for warnings of potential change in the direction of stocks, futures, and currency pairs.

INVESTMENT EDUCATORS

 

Free Charting Lesson

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In the above chart, we have what is known as a "Double Bottom" pattern. To an alert trader, this particular pattern makes for an easy profit. It is also one of the safest patterns to trade. Let's dissect what is going on here, step by step.

First, we drew a trendline across the tops as soon as two lower highs were made. Typically, in an established trend, a market will bump up against such a line three or four times before reversing.Next, we analyze the pattern. Focus on the downswing. In this instance, the price was   contracting as it was making its descent.  The size of  bars on the price chart was smaller  than the bars of the previous downswings.  Normally, there will be five "legs" in the downward progression, and then we will see the reversal. It quickly becomes apparent that no new lows are being made at the first leg of the Double Bottom. So, we look for a  counter-trend rally --- and we get one! With it, there is a penetration of the trendline. This is a major piece of information!What comes next is the clincher that tells you that the trend is changing. Price comes back down and touches the trendline, but is unable to make a closing price beneath it.Since the pattern spells a reversal in trend, we then look to Stochastics to confirm what we think will happen. Stochastics, which was developed here at Investment Educators by our own George Lane, is a momentum oscillator. Its function is to detect changing velocity in trends. Take a look at the first bottom that the pattern made…the one before the trendline was first penetrated. Look where Stochastics was at the time. Next, look at where the retest of the low was made and observe where Stochastics was at the time of the retest. The second low on Stochastics was higher than the first low on Stochastics, while the price was making equal lows. This is called convergence. Convergence indicates that the momentum has sufficiently changed to predict a reversal in trend. It confirms that the bottom has been made.

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On the way up, it quickly becomes apparent that this is a strong, uptrending market. This market is in a hurry to go someplace and we can know this by looking carefully at the size of the "reactions, or "countermoves" that it makes on its way up. They are very small and short-lived. This indicates the aggressiveness of the bulls.Catching a strong trend like the one shown is what traders live for. They don't come like that every day, so we like to stay in them as long as possible. To accomplish this, there are methods available that will assist us in determining how far a market can go in one direction before correcting again. Elliott Wave is one method that can do this with awe-inspiring accuracy, so we teach it along with Stochastics in our 2-Day Seminar!We hope you have enjoyed this lesson. Good luck and good  trading!……………………………………………………………..

MACD is a trend velocity indicator developed by Gerald Appel in the 60' and is constructed as a center line velocity oscillator.    The Moving Average Convergence Divergence indicator is a popular indicator that is available everywhere.

What MACD does: the formula plots the point spread between 2 different Exponential Moving Averages--a slower and faster one. This is the first line.  Then a second Exponential Moving Average is plotted against the first.   MACD can also be constructed as a histogram.  MACD histogram is often easier for novices to use.

Professional market technical analysts agree that MACD requires experience and judgment to use as Appel intended.  Gerald Appel doesn't recommend its use as a purely mechanical indicator.   The most common problem traders experience when using the moving average convergence divergence indicator is frequent whipsaws which may cause chronic small losses.   To find out how you can improve how you use MACD, please watch the free MACD lesson.

Today we have a very dynamic, energetic, and often volatile market that is dominated by institutional traders who do swing trading, day trading, selling short, hedging and more.  It is important to include all 3 pieces of market data on your stock analysis. 

To find out more, please watch the free MACD lesson. 

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