Should you look at the companies cash flow statements or MACD stock before you buy? Should you base your trade decisions on fundamental or technical analysis? I forgot to mention the news, does it matter? Do you have any idea what I am talking about? If you have the deer in headlights look, don’t worry.
Let’s look at this a little closer because I’m going to explain how to use momentum indicators so you can profit from them.
Table of Contents
What Is MACD on a Stock Chart?
The MACD indicator is a trend following indicator. You’ve heard the saying, ” The trend is your friend” right? When it comes to trading, it really is. Have you ever tried to swing trade when the market can’t choose a direction? It’s next to impossible. A MACD stock can help you trade that trend whether you’re momentum trading or swing trading.
Understanding the Difference Between Fundamental Analysis and Technical Analysis
You most likely have heard people referring to trading on the fundamentals or trading on the technicals. For starters, fundamental traders look at companies‘ earnings announcements, cash flow statements, long-term stock charts and analysts upgrades and downgrades.
All of this is to determine if the company is one to invest in for the long haul. Fundamental traders are the “buy and hold” investor.
You may be a fundamental trader and not even know it. Likewise, if you hold long-term investments, that’s you. Maybe you have a financial planner or an investment advisor who does the fundamental analysis for you.
Either way, you or your licensed financial advisor looks at the fundamentals before selecting any security for your portfolio. Which may or may not include a MACD stock.
Technical Traders
Traders who trade on the technicals do so in an attempt to identify trends in the short term. At this point, it’s safe to say, the most common indicators we use are momentum (RSI, MACD), trend indicators, volume, VWAP, volatility, relative volume and float.
So a MACD stock would be included in that list. In fact, our weekly stock signals look at momentum indicators when looking to put these on our watch lists.
Today We Will Talk About the Importance of the Momentum Indicators
Before we get to MACD stock, we need to rewind and explain what a moving average (MA) is. A moving average smooths the price of a stock by averaging its past prices.
Generally, the most commonly used MAs are the Simple Moving Average (SMA). In other words, it’s the simple average of a stock over a defined number of periods, for example, 1-minute, 5-minute, or daily charts.
Conversely, the Exponential Moving Average (EMA) gives weight to more recent prices. The most common MAs applications are to identify the trend direction and determine support and resistance levels.
Personally, I use the 9 EMA, 20 EMA, 50 SMA and 200 SMA on all of my charts. Luckily, your charting software will have most of the MA’s already built into it.
Now, let’s turn to the topic of today: The momentum stock indicator MACD
What Is MACD?
One extremely popular momentum trading indicator is the moving average convergence divergence (MACD) oscillator. The MACD stock indicators are used to determine the strength, direction and duration of a trend through the relationship between two moving averages. Sorry for the long-winded answer, but the MACD indicator throws a solid punch.
Using MACD Stock Charts
As I mentioned above, momentum indicators measure the existing trend’s strength and whether the trend is intensifying or decreasing.
Without this information, you’d be entering into a trade blind and worse yet, after the opportunity has passed. Don’t be a FOMO trader. All of this is quite valuable information, don’t you think?
Now that I have you convinced, you need to sit your butt down add the MACD indicator to your stock chart. You’re not going to believe me when I tell you this, but it’s painfully easy.
All you do is go to your indicator list on the charting platform, scroll down to MACD and tick the box. Yes, that is it, that is all. And once you add the indicator, the stock chart looks like this:
Naturally, your next question is most likely: How do I use the MACD stock trading indicator? Great question, here’s how:
How to Use MACD When Trading Stocks
Did you notice that when picking MACD did you had a few choices of time frames to select from for your moving averages? Well, it’s up to you, but I typically use the 12-day and 26-day exponential moving averages (EMAs). We create the MACD line (red line by calculating the difference between the EMA12 – EMA26. Our final step is to plot 9-day EMA (black signal line) on top of the red MACD line. The outcomes function as our buy or sell triggers.
The histogram shows the difference between the MACD and the signal line. If you look at the graph above, you will notice that the histogram is positive (value > 0) if the red line (the MACD line) is above the black line (signal line).
MACD Stock Key Takeaways
- Higher blue bars in the histogram means ascending movement is gaining strength
- Blue bars get shorter as the upward trend is losing strength
- As soon as the MACD line falls below the signal line, you will see the blue bars appear below instead of above the zero line; this is not a strong buy signal.
- Don’t rely solely on MACD to enter trades; use another technical indicator such as the RSI to verify.
To say this a little simpler, if the:
12 day EMA>26 day EMA = +MACD = upside momentum is increasing = POTENTIAL BUY*
12 day EMA<26 day EMA = -MACD = downside momentum is increasing = POTENTIAL SELL*
*see my comments below regarding false signals
MACD Stock Displaying Buy and Sell Signals
Buy and sell signals are displayed by the MACD oscillator when there is an upward or downward crossing between the red and black lines.
However, the results that the indicator gives for going long or short are not in themselves sufficient to allow trading based on these results alone.
There are, in fact, many false signals. To prevent this, I suggest verifying trends with the RSI indicator and looking for bullish and bearish divergence.
Which Is Better MACD or RSI?
You can have a MACD stock or you can use the RSI on your stocks. Are they the same or different? The only difference between the two is that the MACD doesn’t band. However, RSI has upper and lower bands. Angel from our trade room is a huge fan of RSI bands. They keep a stock contained. So if price moves out of the bands, she knows it’s going to pop back inside. So you either wait to make a trade, or trade the play back into the RSI bands.
RSI Momentum Indicator
Like the MACD stock indicator, RSI also belongs to the family of momentum indicators in technical analysis.
By definition, RSI is the average gain of up periods during a specified time frame divided by the average loss of down periods. Usually, it’s over 14 trading days, and the number will tell us if a reversal is coming.
The RSI Momentum Indicator is a pretty powerful indicator and one the savvy day trader should heed. It measures a percentage scale from 0 to 100 and is most advantageous when you can’t see a clear trend in its stock.
For each swing in price up, there is a corresponding upswing in RSI. When price swings down, RSI also swings down.
What Do the RSI Percentages Mean?
RSI > 70% = Overbought
What does this mean? The stock is overbought and is trading near the top of its high-low range; thus primed for a reversal in the down direction
How to capitalize on this? This could be a great time for a short entry. Alternatively, if you’re long in the stock, it’s time to exit your position
RSI< 30% = Oversold
What does this mean? The stock is oversold and is trading near the bottom of its high-low range. Thus primed for a reversal in the up direction.
How to capitalize on this? A great time to enter long on the dip.
Be Careful of False Signals
Momentum indicators are crucial tools for traders and powerful ones when combined with other technical indicators.
Once a direction’s been established, momentum indicators are valuable because they tell us the strength of price movement trends and when the end is near.
As with all other technical indicators, as far as the MACD stock indicator is concerned, you can’t just rely on all the signals as buy and sell triggers.
Honestly, this is because there are just too many (false) signals. However, there’s an easy fix. All you need to do is combine additional momentum indicators such as RSI. Used properly, you’ll filter out a lot of false signals.
Protect yourself from false signals by asking yourself this simple question. Does price agree with momentum?
Are the price and the indicator are going in the same direction? Do they agree or disagree? If they disagree, we call this a divergence. A divergence is when there is a disagreement between a technical indicator such as RSI or MACD and price. A divergence means there’s a high probability that something is going to happen.
What Does It Mean When You Spot a Divergence?
Price is not going the direction it “should” be according to the indicators. For these reasons, if you’re about to go long because the price is trending up, but the RSI or MACD disagree, DO NOT ENTER THE TRADE.
What if you’re already long? Exit now, take your money and run before it turns around.
On a more positive note, if you prefer to short, spotting a divergence is money in the bank.
