Study Guides
Study Guide: Learn the MACD

 MACD Facts:

- MACD stands for Moving Average Convergence Divergence.

- It's simply a trend following momentum indicator.

- Chris typically uses the 3,10,16 MACD.

- The MACD consists of 2 lines:

  1. The Short-Term line, in red, is the difference between two moving averages. I use the 10 period and the 3 period simple moving averages. The difference is a line that can be positive and negative.
  2. The blue line is the Intermediate Line. It is the Simple Moving Average of the Short Term Line. I use a 16 period simple moving average. 

How to use the MACD:

Using the Red MACD Line. 

I use the Red Line much more often than the Blue Line. I use the Red MACD line to look for 6 things.

1. Overbought readings

2. Oversold readings.

3. Positive divergences.

4. Negative divergences

5. Positive reversals.

6. Negative reversals

Using the Blue MACD Line:

The Blue MACD line is used to determine changes in intermediate term direction. A cross above the zero line is a sign of a positive trend change. A cross below zero is a bearish development. The Blue line crossing the zero line shows direction.

Using Both MACD Lines:

There are 4 things to watch with the 2 MACD lines:

1. The slope, or direction of each

2. The location of each, relative to the zero line.

3. The crossovers of the zero line.

4. The crossovers of the 2 lines with each other. 

Why Are Divergences Important? 

When a stock moves, momentum should move in the same direction. The MACD can be used to spot weakening momentum in a stock trying to make new highs. Conversely, you can look for strengthening momentum in a stock making new lows. These divergences are usually the first “tell” that a trend change in imminent.

What Is A Negative Divergence?

The 3,10,16 MACD is great at spotting divergences. A negative divergence is when stock price goes to a new high, but the Red MACD line fails to go to a new high. It is a warning sign to look to get out of longs, or start to look for a short idea. It HAS to be used with moving averages to time entries.

What Is A Positive Divergence?

Positive divergence is just the opposite of negative divergence. It occurs when price goes to a new low, but the Red MACD fails to follow. It is warning sign to get out of shorts, or to think of initiating a long. It HAS to be used with moving averages to time entries.

Reversals:

What is a Positive Reversal?

One of the benefits of using the 3,10,16 MACD is the ease in identifying positive and negative reversals. A positive reversal is when price sells off to a level higher than the last sell off, but the MACD goes to a more oversold condition than the last sell off. This oversold condition gives the stock a lot of energy to resume its uptrend.

What is a Negative Reversal?

As the name implies, the negative reversal is the opposite of the positive reversal. It occurs when the stock is failing to surpass its last high, but the MACD is higher than the last rally. Most of my favorite shorts are when a stock becomes “overbought in a downtrend.”

Bulls vs. Bears:

Bullish Configurations using both lines: 

The best bullish formations occur when the blue line is above zero, or approaching zero with a positive slope, indicating intermediate term strength, while the red line is under zero, but “hooking” up. These buy signals are even more powerful when the blue line slope is positive. I trust the buy signals more when the stock price is above the 49 EMA.

Bearish Configurations using both lines: 

The best bearish formations occur when the blue line is below zero, or approaching zero with a negative slope and the red line is “hooking” down. These sell signals are more powerful when the blue line slope is negative. Sell signal are much more reliable when the stock price is below the 49 EMA.