The MACD or Moving Average Convergence Divergence is pretty widely used by technical traders because it allows you to identify short-term trends. I use it everyday and the times that things have gone south for me were usually because I failed to read the MACD indicator correctly. So let me start with the basics:
- Moving Average: The MACD uses exponential moving averages, which basically means that the latest data points are weighted more heavily. This allows you to have a better understanding of the current trends, without having the earlier data skew the calculation.
- Convergence: this means to meet or come together. When dealing with technical analysis, this means that the stock (future, index, whatever you’re looking at) is moving in the same direction the indicator is.
- Divergence: this is the opposite of convergence, the indicator is going against the trend of the observed asset. Divergence is usually the occurrence that most traders are looking for because it indicates a change in the current trend. You want to take advantage of this trend change!
The MACD uses the Exponential Moving Averages (EMA) of 12, 26, and 9 days. In order to calculate the MACD, you subtract the 26 day EMA from the 12 day EMA, whenever these points meet, you plot them in the “zero” line that can be found in the middle.
The blue line is the 12 day EMA, the yellow/tan line is the 26 day EMA, the 9 day EMA are the red and green bars coming from the “zero” line. When you have a strong upward trend, the 9 day EMA will be a much brighter green and when the opposite is true, the EMA will be a brighter shade of red.
The circled section indicates that the short term EMA has surpassed the long term EMA, which means that the momentum is signaling a change in upward momentum.
You can also see a spike in volume, which is very common as soon as the bell rings, accompanied by a strong “green EMA” indicator, a good sign that this stock will be trending upwards.
Now that we’ve established that this stock has a relatively high chance of keeping the upward trend going (remember it takes one person to completely change this outlook, one big player can send this all to the crapper) I would wait until the MACD crosses over the “zero” line to buy it. Keep an eye on the volume, as well as the 9 day EMA once you hold the position.
Now that we’re riding profit out, I normally would glance over the 9 day EMA and feel out the momentum of the price pattern and sell towards the top of the MACD signal. As you get closer to the top of the MACD, the 9 day EMA becomes a dimmer green, which indicates momentum is not as strong and could end up going the other way. Now, you can be a badass and ride it out all the way to $2.38, but why take the risk? We don’t know how long the ride is going to last, so just take what you can before you crash.
I hope this helps! As always, please feel free to let me know what you think, feedback is welcomed and greatly appreciated 🙂