The Moving Average Convergence Divergence indicator, more generally known by its acronym, MACD, is a readily available tool to analyze stock price movement. Based on moving averages and easily charted, the MACD, like other tools of technical analysis, is used to predict future price movements. Investors need to have a thorough understanding of the MACD and practice to make the most of it.
A moving average is simply the average price of a stock over “n” number of days prior to the current. By itself a moving average provides insight into investor sentiment. If the current price of a stock rises above its moving average, investors would regard it as bullish. If the current price falls below the moving average, the investor outlook is bearish. The length of a moving average (e.g., 10-day, 20-day or 200-day) that an investor employs reflects the time horizon he is investing in (e.g., day trader, short-term, buy-and-hold). When two moving averages are analyzed together, their relative movements show investors likely stock movements.
The MACD is an index that tracks the daily difference between two moving averages -- one half the duration of the other. The index fluctuates around a zero base line. If the MACD is positive, it is bullish since the short-term sentiment is stronger than the longer. Conversely, if the MACD is negative, it is bearish since short-term sentiment is weaker than the longer. MACD analysis is enhanced by the addition of a nine-day moving average of the MACD (not the underlying stock) called the “trigger” line. All of these lines can be plotted using free investing programs on the Internet.
MACD trend lines can be interpreted in a number of ways. Some investors use MACD to identify overbought and oversold conditions. When the MACD rises -- the short average pulls away from the longer average -- the stock is becoming oversold and ready to rise in price. Crossovers occur when the MACD crosses the trigger line. The crossover represents a movement by the short-term trend that is stronger than the longer. It is a buy signal when the MACD crosses above the trigger line and a sell signal when it crosses below. Divergence occurs when the trend of a stock does not follow the trend of the MACD. When the MACD reaches a new high and the stock does not, the outlook is bullish since the stock price will likely follow the MACD. When the MACD reaches a new low and the stock price does not, the outlook is bearish.
However concise an indicator appears it must stand the test of accuracy. Like all stock market indicators, MACD is not always accurate and may be subject to volatility. Although it is simple in appearance, it may be difficult to interpret. Investors should not consider it to be an absolute predictor. Instead, investors should also consider the fundamentals of a stock and use the MACD as a tool in conjunction with other technical indicators.
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