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crossing the Linethe macd tries to pinpoint the moment when a stock’s momentum shifts

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by JenniferPellet

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recent closing prices because they provide additional information about the stock’s current situation. In a MACD analysis, the difference between two moving averages (typically, the 26-day EMA is subtracted from the 12-day EMA) is plotted as a line on a graph referred to as the MACD, or “fast,” line. A second line — known as the signal, or “slow,” line and usually representing a nine-day EMA calculated for the MACD itself — is plotted alongside the first.

For investors using the MACD, what’s important is how the fast and slow lines interact — particularly when they cross over each other, explains Derek Moore,

Director of National Education for TD AMERITRADE. “Traders generally view a MACD line above the signal line as more bullish than bearish,” he says. “But when the MACD line has been below the signal line and then crosses above it, that indicates the price may be turning more positive on a near-term basis. Traders see that as a trigger — as a potential time to buy or at least to watch the stock more closely.” Conversely, a dip below the signal line by a MACD is viewed as a negative crossover, suggesting the beginning of a possible price drop.

The difference between the MACD and the signal line is often plotted as a histogram,

t he MACD may sound like a new offering from a particular fast-food chain, but it’s really a technical tool

that serves as an investment barometer for traders. MACD, or moving average convergence/divergence, is a momentum indicator that signals when a trader might want to buy or sell a stock.

The MACD is computed using exponential moving averages (EMAs) of stocks. Unlike a simple moving average, which is calculated by adding up a stock’s closing price each day during a specified period, then dividing by the number of days, an EMA employs a formula that gives greater weight to more

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solid bars that extend above zero when the MACD line is above the signal line, and below it when the MACD line is under the signal line. The length of the bars represents the distance between the MACD and signal lines. “Another area of interest is the center line,” Moore says. “Traders look for the MACD to cross above or below the center line as a second signal to confirm a potential entry or exit point.”

Crossovers alone, however, can be misleading, and it’s crucial for investors to employ the MACD as just one of several analytical tools. For example, because it relies on historical prices, the MACD is a lagging indicator and functions best when a market or security is trending upward or downward. In a sideways market, a crossover can “whipsaw,” or reverse quickly, burning an investor who acts precipitously or without an exit strategy.

Moreover, the MACD is unique in that it combines a moving average–based indicator and an oscillator, an indicator that fluctuates above and below a center line as its value changes. “While there are no upper or lower limits to a MACD’s values, traders using oscillating indicators tend to perceive the stock as being overbought or oversold when prices hit the upper or lower end of the period being studied,” Moore explains. “So when the MACD rises into the higher ranges of the study, a trader might want to consider a defensive action. With any technical indicator, you always look at price first.”

Investors new to using the MACD or interested in trying out a combination of technical analysis tools can gauge the potential effectiveness of their strategies with the backtesting feature on TD AMERITRADE’s new StrategyDesk™ tool. “You can enter your trading methodology m

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“with technical analysis, you position yourself for success by taking emotion out of the game and instilling discipline.”— Derek Moore, Director of National Education, TD AMERITRADE

— buying certain stocks or the entire S&P 500 for a specified period every time there’s a MACD crossover, for example — and it will show you all the trades you would have made and what the hypothetical results might have been,” Moore says. “It’s a great way to test and tweak strategies you’re considering.”

Backtesting can provide some indication of a strategy’s potential, but no technical tool is foolproof, Moore cautions. “Seasoned traders know you can’t expect to buy at the bottom and sell at the top 100% of the time,” he says. “With technical analysis, you position yourself for success by taking emotion out of the game and instilling discipline.” n

analyzing a macd chartwhen the macd line crosses above the signal line after remaining below it, traders often expect a positive price jump. But beware when a macd crosses below the signal line, which might suggest the beginning of a price drop.

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Backtesting is the evaluation of a particular trading strategy using historical data. Results presented are hypothetical; they did not actually occur. Past performance of a security or strategy does not guarantee the security or strategy will be successful in the future. Results could vary significantly and losses could result. In order for a programmed trade to be automatically entered when the conditions you set are met, your computer must be on and StrategyDesk must be running. You are responsible for all orders entered in your account when a program trade you set is activated. Please make sure you keep sufficient funds or positions in your account to support program trades. StrategyDesk is a trademark of TD AMERITRADE IP Company, Inc. Used with permission.