Every investor has his favorite or favorites when it comes to stock market indicators. Most of them fall into one of two categories - momentum or oscillators. Momentum indicators are speed and strength or rate of change indicators that are designed to visually represent the speed and strength of a price movement whether up or down. This is usually done by comparing the latest closing price with an earlier closing price. An oscillator is a visual representation of trend that has upper and lower limits for determining overbought and oversold conditions. The minimum is usually zero and the maximum is usually 100. An oscillator at an extreme is usually about to reverse momentum.
One of my favorites is the MACD (Moving Average Convergence Divergence). This indicator is a simple and effective indicator and I like indicators that are simple and effective. Why make things more complicated than necessary? The MACD was designed to calculate a line using the difference of two moving averages. This line is calculated by subtracting the 26 day exponential moving average from the 12 day exponential moving average. Once that is calculated and plotted, a 9 day exponential moving average signal line is calculated and plotted along with the MACD.
As the MACD crosses back and forth across the 9 day signal line it is interpreted that a change in momentum for the underlying price of the stock has occurred. I personally use this market indicator to determine the speed and strength of the momentum of the stock price of the company I am charting as well as the stock price’s change in momentum. As the MACD converges and diverges from the signal line I can visually see the change in the speed and strength of the stock’s momentum.
Here’s one of the little known pieces of information that I’ve learned using this indicator over the years that is detailed in Gerald Appel’s book “Technical Analysis, Power Tools for Active Investors” but you really have to read it close to get this point. Crossing the signal line is most effective when the MACD is below zero and crosses the signal line from below or above zero and crosses the signal line from above. Crossing from below when it is above zero and crossing from above when it is below zero is generally a false signal and many beginning traders make the mistake of trading this false signal. In addition, the MACD crossing the signal line is the initial signal and the subsequent crossing of the zero line is a confirmation of that signal.
For additional information on this indicator I refer you to the experts at StockCharts.com. They have an area of their website that is called their Chart School and they have a specific page dedicated to the MACD. There you’ll find a vast array of information on market indicators as well as chart analysis. It’s well worth a look but you need to set aside a little time to do it.
Before I end this I’d like to personally thank Gerald Appel for developing the MACD. I have not only used it extensively over the years to make money in the stock market but I have also used it to avoid losing money as well. Thank you Mr. Appel.