MACD is an acronym for Moving Average Convergence Divergence. It is a technical indicator. Technical Indicators are those elegant computerized studies that you usually see at the bottom of price charts that are supposed to tell where the price should go. The most common include Stochastics, RSI, and ADX, just to name a few. However they can divert your attention from what’s most important – PRICE and you must know how to use them correctly to make the most out of them.
Out of the various technical indicators, I have worked with over the years, my all time favourite study is MACD. It was developed by Gerald Appel uses two exponential moving averages (12-period and 26-period). The difference between these two moving averages is the MACD-line. The signal line is a 9-period exponential moving average of the MACD-line (usually seen as 12/26/9…so don’t misunderstand it as a date).
The simplest trading rule for this indicator is to buy when the Signal line crosses above the MACD-line, and sell when the Signal line crosses below the MACD-line. Although many people use this indicator this way, it is not a good approach, primarily because MACD is a trend-following or momentum indicator. An indicator that follows trends does not work in a side- ways market (which is the state of markets most of the time) and will get your capital destroyed. For that purpose, I have created a list of patterns observed using this indicator that work successfully in any time frame.
How to Use the MACD Indicator ?
A Hook occurs when the Signal line penetrates, or attempts to penetrate, the MACD-line and then turns at the last moment. Those who like to buy pullbacks in uptrends and sell bounces in downtrends would love hooks because Hooks do just that – they identify counter trend moves within trending markets. In addition to identifying potential trade set- ups, you can also use Hooks as confirmation. Rather than entering a position on a cross- over between the Signal line and MACD-line, wait for a Hook to occur to provide proof that a trend change has indeed occurred. Doing so increases your confidence in the signal because now you have two parts of information in compliance. Well, a picture is worth a thousand words. Here is it.
Zero-Line Reversals or Rejection
A Zero-Line Reversal occurs when either the Signal line or the MACD-line falls to near zero and then turns. It’s related in concept to the hook technique described above. The difference is that instead of looking for the Signal line to reverse near the MACD-line, you’re looking for reversals in either the Signal line or the MACD-line near zero. If MACD reverses above the zero-line, it is a bullish signal. When a Zero-Line Reversal occurs from below, it’s bearish. Let’s look at an example of Zero-Line Reversal and I am sure you’ll see what I suggest.
To get a mental snapshot of this indicator pattern, think the opposite of divergence. Divergence occurs when prices move in one direction (up or down) and an indicator based on those prices moves in the opposite direction. A bullish hidden divergence occurs when the current swing low is above a previous swing low (swing lows or highs are simply previous extremes in price),while the corresponding readings in MACD are just the opposite. A bearish hidden divergence is just the opposite. Prices make a lower swing high than the previous swing high, but the corresponding extreme in MACD is above the previous extreme.
So there you have it, a set of patterns using the MACD indicator that lead to potential trading opportunities. These techniques can help you to spot trades. These were some of the best and most successful setups which work in any time frame and with which you can make huge profits if you use it diligently.
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