Moving average convergence divergence (MACD) trading is a lagging technical analysis indicator used to spot reversals. It calculates the difference of two exponential moving averages; the 12 and 26 EMA’s. Traders might buy the stock when price rises above the signal line and sell when price action crosses below signal line.
What Is MACD Trading & How Do You Use It?
- MACD trading calculates the difference of two exponential moving averages, which are the 12 and 26 EMA’s. The 26 EMA is slower than the 12. This is a lagging indicator but many people use it for potential early warning reversal signals.
The MACD is a popular technical indicator used in trading for all types of traders. It’s simple and flexible; finding the momentum or confirming a trend. At times, the MACD trading strategy is used to find entries and exits.
The stock market is a battle of the bulls and the bears. Each trader is trying to get a piece of the win. In order to do that, traders look for tools to give them the advantage over others.
Basics of MACD Trading
The Moving Average Convergence Divergence calculates the difference of two exponential moving averages; the 12 and 26 EMAs. The 12 EMA is faster than the 26 EMA.
Add the closing prices of the time periods being measured between the 2 EMAs. You can add in the 9 EMA to track buy and sell signals. Hence the name signal line. However, remember that this is a lagging indicator. MACD trading should be used in conjunction with candlesticks and patterns.
MACD trading has different strategies you can use. These strategies can be quite helpful to use for trading the stock market.
MACD Trading Crossovers! Momentum! Oh My!
MACD trading crossovers are one of the most popular MACD trading strategies, especially when you trade penny stocks. The Moving Average Convergence Divergence cross can be either bullish or bearish in nature.
When the moving average lines of the MACD cross, this can be used to get in or out of a stock. It has the red and green bars that confirm bearish and bullish moves.
As a result, the MACD crossover can and is used as confirmation of a trend or momentum change. Traders use it to avoid getting faked out on a move. When this happens you might look to short.
For example, when the Moving Average Convergence Divergence falls below the signal line, things are bearish. The opposite is also true. When MACD raises above the signal line, the bulls are in control.
However, remember to use other forms of technical analysis to confirm moves.
The Divergence of MACD Trading
The divergence is one of the most popular strategies of MACD trading. However, it’s also the least successful; especially when done without the help of other technical indicators and patterns.
MACD divergence is when the price of a stock moves away from the MACD. It signals the end of a price movement or trend.
For example, price can be moving up or down opposite of the direction. For instance, if price is moving up while the MACD is falling, traders may see it as a rally about to end.
Consequently, if price is moving down while the MACD is moving up, then that can be seen as a bullish reversal getting ready. However, this strategy isn’t an accurate one.
Prices can have a few bursts that can trigger stops as well as forcing traders to exit a trade before it’s made them money.
The MACD can look to be crossing over. As a trader, you’ll always want to get the best entry. Who wouldn’t want to enter a trade as this indicator was moving into new territory?
However, that kind of thinking has frustrated many traders over the years trying to trade the MACD divergence.
As a result, using candlesticks as well as patterns in conjunction with RSI and moving average lines allow you to not get faked out. We teach how to put all of this into action live in our trading rooms each day.
The Dramatic Rise Strategy
MACD trading strategies also include the dramatic rise. This occurs when the MACD rises dramatically. Seems obvious right? Hence how it got its name.
The shorter moving average pulls away from the the longer moving average. This actually signals that a stock is overbought or oversold depending which direction it’s crossed. Timing this signal with other chart indicators, price action or breath indicators is essential for confirmation.
For example, many traders confirm this move with the RSI. The relative strength index is used as a tool to see when a stock is overextended in either direction.
This signals a pullback is coming. It also confirms the strength of a trend. The RSI can stay in oversold or overbought territory for a few weeks. Hence confirmation of a strong trend in place (check out our day trading strategies page).
You can see with Target that the MACD traded in tandem with the RSI and moving average lines. The farther the candlesticks moved from the moving averages the more the MACD rose and the RSI dabbled in overbought territory. As it traded sideways, so did the other indicators.
Using Other Indicators With Macd Trading
MACD trading requires the use of other technical analysis. Fake outs are one of the great tools of taking a traders money. Many times bulls and bears get trapped after being tricked into a trade.
MACD trading by itself wouldn’t stop that from happening. However, when you add in other forms of technical analysis, you get confirmation of moves (try our stock picks for free).
When you’re trading, you’re required to make split second decisions; especially when trading low float stocks. If you have a large position in a stock and it was place on a fake out, you could be hurting.
As a result, using other indicators can confirm moves. Support and resistance might be the most important trading strategy to know. First you should know how to map those levels out.
Then you can add in other indicators. MACD trading is best used in conjunction with other forms of technical analysis, and is most effective when a price action trading approach is taken to the chart. Looking for 3d stocks? Check out our latest post.