Category ArchiveIndicators

Trading with the MACD

The Moving Average Convergence Divergence (MACD) for Short.

MACD on the Chart

The Moving Average Convergence Divergence, (MACD) is an indicator used in technical analysis, It can be used to find changes in the strength and momentum of a trend.

The MACD indicator, also known as an oscillator, showing the difference between a short period exponential moving average (EMA), and a longer period EMA of the price series. The average series is an EMA of the MACD series itself.

The most commonly used values for the parameters are 12, 26, and 9 days, that is, MACD 12,26,9.  As the working week used to be 6-days, the period settings of 12, 26, 9 represent 2 weeks, 1 month and one and a half week.  These are settings used by the majority of traders.

The MACD is based on exponential moving averages, and is a lagging indicator. The short EMA responds quicker than the long EMA to changes in price. But by comparing the different periods, the MACD can indicate changes in the trend.

The MACD divergence is shown as a bar graph, often called a histogram, the difference between the MACD and the Signal line, the height of the bar corresponds to the MACD value for a particular point in time and is plotted as a histogram.

The divergence refers to the two exponential moving averages drifting apart, the convergence refers to when the two exponential moving averages coming towards each other.

A bullish divergence can occur when the price makes a new low but the MACD does not confirm this with a new low of its own and a bearish divergence can occur when the price makes a new high but the MACD does not confirm this with a new high of its own.  

By comparing the exponential moving averages the MACD can show changes in the trend of price and most traders will give significance to the MACD line crossing the signal line, or the MACD line crossing the zero axis.

When a signal-line crossover happens, if the MACD line crosses up through the average line, this showing a bullish crossover, to buy, or to sell if it crosses down through the average line this to show a bearish crossover. These events can be interpreted as a signal that the trend in the trend is about to accelerate in the direction of the crossover.

The zero crossover occurs when the MACD series changes sign, that is, the MACD line crosses the horizontal zero axis. For this to happen there is no difference between the fast and slow EMAs. A change from positive to negative MACD can be interpreted as bearish, and from negative to positive as bullish. Zero crossovers can provide evidence of a change in the direction of a trend.

Trading with Bollinger Bands

Bollinger Bands were invented by John Bollinger way back in the 1980’s and are so popular in trading, most traders and analysts would always be keeping the Bollinger Band close to hand to help give them the trading edge.

Bollinger Bands are placed in two standard deviations away from the simple moving average to keep a check on the measures of volatility.

The default parameters are the 20 period and two standard deviations which can be changed to each persons preference.

 

How to Trade

When a candle touches one of the bands, it signals the price has reached a point at which buyers have bought or sellers have sold, these can indicate a Call or Put, when a candle touches the top band, that can be an signal for a Put and when a candle touches the bottom band that can be a signal for a Call position.

Another interesting note, when volatility drops, the Bollinger Bands come closer together and can form a tight squeeze… get ready, a massive move is about to take place, so have a Call or Put ready.