A trend-following momentum indicator that shows the connection between two moving averages of prices, the MACD is calculated by subtracting the 26-day exponential moving average from the 12-day exponential moving average. A nine-day exponential moving average of the Moving Average Convergence Divergence (MACD) momentum indicator, called the “signal line”, is then plotted on top of the MACD, operating as a trigger for buy and sell signals.

There are three common ways used to interpret the Moving Average Convergence Divergence (MACD):
1. Crossovers - when the MACD falls below the signal line, it is a bearish signal, which indicates that it may be time to sell. On the contrary, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Many traders wait for a definite cross above the signal line before entering into a position to avoid getting getting “faked out” or entering into a position too early. However, keep in mind that by doing so, you could limit possible profits and take on additional losses.

2. Divergence - When the security price diverges from the Moving Average Convergence Divergence (MACD) momentum indicator. It signals the end of the current trend. When the fast- and the slow-moving average lines move away from each other, the heap on the chart expands. As these lines draw close to each other, the heap shrinks. Divergence is an important day trading tip that can build up your position on a trade if read correctly.

3. Dramatic rise - When the (MACD) momentum indicator rise dramatically – that is, the shorter moving average pulls away from the longer-term moving average – it is an indication that the security is overbought and will soon return to normal levels. When you’re day trading stocks, you may be told to trade on the cross, but here is a little idea you can add to your strategy instead of just trading at the cross. What you can do is check if the indicator line is moving in the same track and test the indicator line as being a support or resistance line after the cross.

Forex traders also look for a move above or below the zero line because this signals the position of the short-term average relative to the long-term average. When the Moving Average Convergence Divergence (MACD) momentum indicator is above zero, the short-term average is above the long-term average, which signals upward momentum. The opposite is true when the MACD momentum indicator is below zero.

The MACD momentum indicator is a great trending indicator that can be used for many day trading strategies. Using the MACD momentum indicator is a good way for familiar day traders to get an idea of when to buy and sell based on averages that give you a rational reason to buy or sell at a particular time.

Tags: macd, momentum indicator, moving average convergence divergence