Should you look at the company’s 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 will explain how to use momentum indicators so you can profit from them.
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 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 in momentum trading or swing trading.
You most likely have heard people referring to trading on the fundamentals or 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” investors.
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, 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.
Momentum Indicators
Before getting to MACD stock, we need to rewind and explain a moving average (MA). 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) weighs more recent prices. The most common MAs applications are to identify the trend direction and determine support and resistance levels.
I use the 9 EMA, 20 EMA, 50 SMA, and 200 SMA on all my charts. Luckily, your charting software will have most of the MA’s already built into it.
Let’s turn to today’s topic: The momentum stock indicator MACD.
What Is MACD?
The moving average convergence divergence (MACD) oscillator is one of the most popular momentum trading indicators. The MACD stock indicators determine a trend’s strength, direction, and duration 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 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.
Now that I have you convinced, could you please sit down and add the MACD indicator to your stock chart? You won’t believe me when I tell you this, but it’s painfully easy.
You 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:
Using MACD When Trading Stocks
Did you notice that when picking MACD, you had a few choices of time frames for your moving averages? 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 and EMA26. Our final step is to plot a 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).
Key Takeaways
- Higher blue bars in the histogram mean the 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, 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.
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 the indicator gives for going long or short are insufficient 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 use the RSI on your stocks. Are they the same or different? The only difference between the two is that the MACD doesn’t have a 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 the price moves out of the bands, she knows it will pop back inside. So you either wait to make a trade or trade the play back into the RSI bands.
Like the MACD stock indicator, RSI belongs to the family of momentum indicators in technical analysis.
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 powerful indicator that 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.
There is a corresponding upswing in RSI for each swing in price. When the price swings down, the RSI also swings down.
RSI Percentages
RSI > 70% = Overbought
What does this mean? The stock is overbought and is trading near the top of its high-low range; thus, it is primed for a reversal in the down direction.
How do we capitalize on this? This could be a great time for a short entry. Alternatively, it’s time to exit your position if you’re long in the stock.
RSI< 30% = Oversold
What does this mean? The stock is oversold and is trading near the bottom of its high-low range. Thus, it is primed for a reversal in the upward direction.
How do we capitalize on this? It’s a great time to enter long on the dip.
Are the price and the indicator going in the same direction? Do they agree or disagree? If they disagree, we call this a divergence. A divergence is a disagreement between a technical indicator, such as RSI or MACD, and price. A divergence means there’s a high probability that something will happen.
Be Careful of False Signals
Momentum indicators are powerful tools for traders 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 rely on all the signals as buy and sell triggers.
Honestly, this is because there are 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?
Final Thoughts on MACD Stock
Price is not going in 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, spotting a divergence is money in the bank if you prefer to short.
