A lot of traders do not know how to use the MACD correctly. The MACD is a trend-following momentum indicator developed by Gerald Appel that shows the relationship between two moving averages of price (normally the close). The MACD line is calculated by taking the difference between a longer-period and shorter-period exponential moving average. It is the interaction of these two moving averages that gives the indicator its name. Over time, the two moving averages are constantly converging and diverging. Exponential averages are used because they respond more quickly to changes in price, since more weight is placed on the most recent price compared to the earlier prices.

Crossovers are probably the most popular use of MACDs: a sell signal is generated when the MACD crosses below the signal line, and a buy signal is generated when the MACD crosses above the signal line. In addition, the locations of these crossovers in relation to the zero line are helpful in determining buy and sell points. Bullish signals are more significant when the crossing of the MACD line over the signal line takes place below the zero line. Confirmation takes place when both lines cross above the zero line.

Using the MACD in this way makes it a lagging indicator. Just like moving averages—which are also lagging indicators—the MACD works best in strong trending markets. Both the MACD and moving averages are intended to keep you on the “right” side of the market (on the long side during uptrends and on the short side or out of the market altogether during downtrends), meaning you buy and sell late.

Technorati Tags: bullish signals, exponential moving average, gerald appel, lagging indicator, lagging indicators, macd, momentum indicator, moving averages, signal line, uptrends, zero line

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