MACD, the Moving Average Convergence/Divergence Indicator
MACD, the Moving Average Convergence/Divergence indicator, developed and popularized by Gerald Appel, provides a uniquely sensitive measurement of the intensity of the trading public's sentiment and provides early clues to trend continuation or reversal. According to Appel, this indicator is particularly dependable in signaling entry points after a sharp decline. The MACD indicator may be applied to the stock market as a whole or to individual stocks or mutual funds.
The MACD indicator uses three exponential moving averages: a short or fast average, a long or slow average, and an exponential average of the difference between the short and long moving averages, which is used as a signal line. (See Moving Averages below for a discussion on simple and exponential moving averages.)
MACD reveals overbought and oversold conditions for securities and market indexes, and generates signals that predict trend reversals with significant accuracy.
MACD produces less frequent whipsaws, as compared with moving averages.
Telescan uses a type of shorthand to refer to MACD indicators. An "8-17-9 MACD", for example, uses a short (fast) moving average of eight days or weeks, a long (slow) moving average of 17 days or weeks, and an exponential moving average of nine days or weeks. (The use of days or weeks depends on the time span of the stock graph.)
Gerald Appel recommends an 8-17-9 MACD to generate buy signals and a 12-25-9 MACD to confirm a sell signal for a stock, which has had a strong bullish move.
Regardless of the accuracy of this indicator, one should not rely on a single indicator. Study as many technical and fundamental indicators as possible before arriving at your investment decisions.
Simple Moving Average
A simple moving average is calculated by totaling the closing prices of a stock over a prescribed period (say, 30 days) and dividing that total by the number of days in the period (i.e., 30). The resulting number is the average. In order for the average to "move", the most recent closing price is added to the previous total and the oldest closing price used in that total is subtracted. The new total is then divided by the number of days of the moving average, and the process repeated.
Changes in the upward or downward trend of the stock being measured are identified by the stock price or index crossing over its moving average, rather than a change in direction of the moving average itself. According to the moving average theory, when a stock price moves below its moving average, a change is signaled from a rising to a declining market; when a stock price moves above its moving average, the end of the declining trend is signaled.
A disadvantage of the simple moving average approach is that it will allow an extreme high or extreme low to distort the true value of the stock, possibly giving false buy or sell signals or rapid whipsaws.
Exponential Moving Average
To overcome the distortion caused by extreme highs or lows, the exponential moving average weights recent closing prices more heavily than earlier closing prices. Many market technicians consider the exponential moving average to be a more accurate indicator than a simple moving average.
To calculate an exponential moving average, Telescan first calculates a simple average for the desired period. Then it uses the following formula for each new moving average:
[ Last MA Value x ( 1 - 2/L+1 )] + [ NP x 2/L+1 ]
MA = Moving Average
L = Length of Moving Average
NP = Most Recent Closing Price of Stock
For example, let's say the simple moving average of a certain stock over a 19-day period is 100 and the stock closed today at 105. If we plug these figures into the above formula (Last MA Value = 100, L = 19, and NP (New Price) = 105), the New Moving Average will be 100.5. The same formula is used to figure consecutive values for the remaining periods.
A buy signal (positive breakout) is given when the MACD graph is in an oversold condition below the origin and the MACD line crosses above the signal line.
A sell signal (negative breakout) is given when the MACD graph is in an overbought condition above the origin and the MACD line falls below the signal line.
Significant MACD signals occur far from the zero line. When the MACD line is far from the zero line, it shows that the public is reacting to the emotion of the trend. Thus, when the crowd surges in the opposite direction and a crossover occurs, the implication is strong. Crossovers in the vicinity of the zero line suggest that public emotion is flat and disinterested and often do not lead to productive moves.
The amount of divergence between the MACD line and the signal line is important-the greater divergence, the stronger the signal.