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I Spy: Spotting Stock Trends at a Glance with MACD

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November 24, 2012

It’s a mouthful. But the Moving Average Convergence Divergence chart indicator can help place you on the right side of critical changes to a stock’s price.

Fashion trends change all the time. Adopting a new trend too soon, or too late, can result in some awkward moments. Think of that poor parachute-pants pioneer, or worse, the guy that just can’t part with his pair.

Chart trends change even faster than what’s walking the runway. And being caught on the wrong side of a stock trend can be more than awkward—it can be potentially disastrous to a trade.

One way to track a stock trend is with a moving average, which shows the stock’s average price over a particular time frame. It “moves” by adding the current day, and dropping the oldest day. Take the concept a step further by adding a second moving average, creating the Moving Average Convergence Divergence (MACD) indicator.

MACD is commonly used to spot changes in the strength, direction, momentum, and duration of a trend in a stock’s price. And, it’s calculated using a short-term moving average (usually 8 or 12 periods), and a longer-term moving average (usually 17 or 26 periods). Typically, as a stock rises, the shorter (and faster) moving average moves above the longer (and slower) moving average. As a stock falls, the shorter moving average falls below the longer.

MACD Chart

FIGURE 1: Notice how the MACD behaves in different market conditions. In the left section of the graph, both lines are below the zero, or equilibrium, level, which is characteristic of a downtrend. On the right side of the graph, the index is up-trending, and both lines are above the zero level. If an investor is looking to enter a bullish position, they would first ensure that both lines are above zero, then look for the faster (blue) line to cross above the slower (red) line. This occurs on the far right of the graph. Data Source: ProphetCharts®. For illustrative purposes only. Past performance does not guarantee future results.

Uniquely, MACD determines both the strength of a stock trend and potential entry points. It’s typically plotted showing the two lines and a “histogram,” which measures the distance between the two lines, helping the technician gauge how soon that crossover might take place. (See Figure 1, above.)

Used with other analyses, MACD is one tool that can potentially be used as a trading signal—dare we say the little black dress—an important basic to include in your trading wardrobe. Trends may change. But having go-to tools never goes out of style.