At the end of the post, I have written about the best trading signal in technical analysis. If you do not want to read the complete post, just scroll down to the end to read it.
Gerald Appel an analyst and money manager in New York developed the more advanced indicator known as Moving Average Convergence Divergence (MACD) and MACD-Histogram.
Moving Averages identifies trends by filtering out ripples in the daily prices. MACD consists of three exponential moving averages. Two lines appear whose convergence and divergence along with its directions gives us trading signals.
I will not go into calculating details of MACD as you can construct the indicator with just a click of a mouse as shown above. Instead I will refer the black line as fast signal line (MACD) and the red line as the slow signal line
When the black line crosses over above the red line, it gives a buy signal and when it crosses down, it give an sell signal. See below image:
Crossovers of black MACD line and red slow signal line helps us to identify changing market conditions. When we trade in the direction of the crossover, it means we are going with the market trend. Though this might generate fewer trades but there is lesser wrong trades or whipsaws.
Trading Rules
- When the black MACD line crosses over above the red slow signal line, we buy into the market i.e. go long and our stoploss is just below the latest minor low.
2. When the MACD line crosses below the slow signal line, it gives us sell signal. The protective stop is just above the latest minor high.
The more simple you keep your trading rules, the easier it is.
MACD-Histogram
The balance of power between the bulls and the bears is better reflected in MACD-Histogram. It shows who is getting stronger or weaker and can be regarded as one of the best tools available to technical analysts.
The red and green bars you see in the above images is MACD-Histogram. The green appears whenever there is an uptick and the green bar when there is a down tick.
The size of the bars depend on the gap between the MACD line and the slow line depending upon whether the Histogram is in positive or negative territory. The area above the zero line is positive and below zero line is negative.
When the MACD line rises faster than the slow line and the gap between the two increase, it reflects the bulls are getting stronger.
When the slow line falls faster than the MACD line and the gap increases, it means the bears are getting stronger.
The slope of the MACD-Histogram is very important.
We can say that when the slope of the MACD Histogram is in the same direction as the prices, the trend is intact. When they move in opposite direction of each other, we need to become cautious as it indicates the trend is getting weaker.
How To Trade Using MACD-Histogram
Before jumping to conclusions, please make sure to read the complete post.
We can buy when the MACD-Histogram stops falling and gives an uptick and similarly we can sell (short) when the MACD-Histogram stops rising and gives an downtick.
But remember that there can be changes in the ticks on daily basis. So it is better to follow the weekly charts and trade on the daily charts.
I mean to say if the MACD-Histogram has given an uptick on weekly charts, we buy using daily charts. For example if the MACD-Histogram has given an uptick on weekly charts, we wait for the uptick on daily charts and buy into the market as soon as we get the uptick on daily charts.
Strongest Signal In Technical Analysis
One of the strongest signals in Technical Analysis is divergence between MACD-Histogram and the prices. This happens only a few times in a year but when they happen, it gives one of the best trading opportunities.
When prices rally and makes new highs but the MACD-Histogram makes a lower top, this makes an negative divergence.
Trade – Go short as soon as MACD-Histogram gives an downtick from the lower top. Place an protective stop just above the latest high.
When prices fall and make an lower low but MACD-Histogram makes an higher low, it forms an positive divergence.
Trade – Go long as soon as MACD-Histogram gives an uptick from the higher (shallow) low. Place an protective stop just below the latest low.
If prices move higher to make new highs in the first case or falls to make new low in the second case, you will be stopped out. Keep an watch on the MACD-Histogram. If it makes an lower top or higher bottom compared to prices again, it forms an Triple Bullish or Triple bearish divergence as the case may be. Take positions accordingly as this is one of the best and profitable signals the markets can give.
Technical Resources 