One Step Ahead
Leader Of The MACD
by Giorgos E. Siligardos, PhD
If the moving average convergence/divergence is essential to your analysis, then an indicator that often leads it at critical situations will be of great interest to you.
The moving average convergence/divergence (MACD) is one of the best-known trend momentum indicators. Introduced by Gerald Appel in the 1960s, it later became widely used with the popularization of personal computers as both an analysis tool and an essential component of trading systems. Its popularity, however, may be why it has lost much of its prestige in the current era. Although MACD has been criticized as a trend indicator that produces many whipsaws and is inappropriate for simple trading decisions, it is nevertheless heavily used as a trend-analysis tool and is offered in most technical analysis reports and newsletters. This article is for those who actively use the MACD and would like to know how to get warning signals of possible changes in its direction.
A SHORT OVERVIEW OF MACD
The MACD is computed by subtracting a 26-period exponential moving average (EMA) of the closing price from a 12-period Ema of the closing price:The main purpose of MACD is to provide a smooth trend indicator, and many analysts use its sign to characterize the long-term trend as bullish or bearish: When MACD is positive, the long-term trend is considered bullish, and when MACD is negative, the long-term trend is considered bearish. For the characterization of the short-term trend, a nine-period EMA of MACD is usually used as a signal line: When MACD is greater than its signal line, the short-term trend is considered bullish, and when MACD is lower than its signal line, the short-term trend is considered bearish.MACD = EMA(12)-EMA(26)
The divergences between MACD and the price are often used by technical analysts as an early warning of a trend reversal. Successively higher highs of the price during a bullish trend, accompanied by successively lower highs of MACD, is considered a negative divergence, and analysts consider this as an indication of a coming trend reversal. Further, successively lower lows of the price during a bearish trend, accompanied by successively higher lows of MACD, are considered a positive divergence. It is also considered a forewarning of a trend reversal.
LAGGING BEHIND PRICE IS NOT ALWAYS BAD
Smoothing methods have lag, and since MACD makes use of moving averages, it usually lags behind price. You cannot eliminate lag completely when trying to filter the price data and take out all its noisy wiggles, but the point of smoothing is to ignore negligible price wiggles. It is the lag that helps reduce the whipsaws in many cases (see Figure 1).
...Continued in the July issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the July 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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