Moving Average Convergence/Divergence (MACD)

MACD is a popular technical indicator used to predict near- term changes in the underlying market. MACD measures the gap between one longer-term moving average versus a shorter term moving average.

The indicator has an equilibrium line valued at zero which its two moving averages cross above and below. It also registers a histogram that graphically shows the gap between moving lines.

MACD is useful to determine whether a market is going up or down in addition to portending possible reversals in sentiment and direction.

When both moving average lines are below the zero-value graph, it indicates bearish sentiment for the issue. Likewise, both moving averages above the zero-value means sentiment is now bullish.

This equilibrium line is extremely important. When both M/A lines cross from one side of this level to the other it indicates a distinct change in market sentiment. Traders look to go long markets that move from below zero value to above and go short those whose lines cross from above to below.

Another valued signal occurs when the fast or shorter moving average crosses over the slow or longer moving average line. The fast line crossing over and moving up signals a bullish move, while the fast line crossing down through the slow line is bearish.

This can occur on either side of the zero line but bearish signals above zero and bullish signals below zero may offer much stronger changes in overall sentiment and possible price reversal.

Histogram bars move above or below their base zero line as the M/A lines cross over each other. Longer histogram bars show the rate of momentum this action is creating. Traders watch the histogram bars for signals of reversal as they converge or diverge with current price action.

Let's review some real examples below:

(daily chart, JNPR)

On the daily chart of Juniper Networks we spot two occasions in April and June where both moving averages switched sides to indicate strong sentiment change. The April move signaled a 60-point decline while the June signal pre-empted an 80-point rally. Large potential gains for astute & patient traders entering plays when MACD signals indicate serious market reversals may lie ahead.

(hourly chart, PDLI )

The hourly chart of human genome Protein Design Labs Inc. points out five solid trade signals within one month's time, an average of one every three days. Can you see where M/A lines cross over each other to indicate new entries?

(hourly chart, ARBA)

Ariba was range-bound and MACD signals remained flat until the breakout was confirmed near July 12th. A 35+ point move to the upside continued from there. Two sell signals followed that warned to protect gains or play the downside if possible.

(hourly chart, JDSU)

JDS Uniphase is an active stock that gives ample opportunity for profit. Five solid signals in fifteen sessions each could have offered great moves to profit from.

(daily chart, SDLI)

Your turn for interpreting the signals! What do you see? Are there any points of entry near $150 in April that finished higher later on? How about profitable buy/sell signals between April and June? What can we expect further price action to be, based upon MACD signals in late July? Is the fast M/A bar crossing the slow? Are histogram bars turning from one side of the zero line to another? How would you trade this developing signal?

MACD technical signals could be blindly traded with positive results but that is surely not their purpose. When combined with other technical indicators they become a powerful tool for near-term market forecast.