In the stock market today, traders use a number of different techniques to help them identify which company will be a good stock pick. Technical analysis is widely used to understand or predict how a particular stock may move. Technical indicators are used to help determine whether an asset is trending, and in which direction it is doing so. One of the simplest and most effective momentum indicators available is the Moving Average Convergence / Divergence or MACD. It highlights the relationship between two exponential moving averages and shows the difference between the moving averages as a signal line. The MACD will fluctuate between positive and negative values above and below a signal line.
When you are trading stocks, and you see the MACD fall below the signal line, this indicates a bearish trend, and it may be wise to sell. However, if it rises above the signal line, it is an indication of a bullish trend, and may see the stock rise in value. Traders call these “Signal Line Crossovers”, as the MACD crosses above and below the signal line.
Divergence occurs when there is a discrepancy between the MACD line and the price action of the stock. When the stock records a lower low but the MACD forms a higher low, a bullish divergence develops. Bullish Divergences tend to occur during strong downtrends and caution should be exercised during a divergence. A bearish divergence will occur when the stock records a higher high and the MACD forms a lower high. During a strong uptrend, it is common to see bearish divergences.
The MACD can sometimes give false signals, so it advisable to look at other indicators to help avoid this. Some analysts use other indicators like the Relative Strength Index to filter out false signals. This is important to do when you are stock picking, as it helps to avoid buying or selling at the wrong time. Because it works by looking at differences in moving averages, it is only useful as trends change. If the market or stock has a flat trend or is erratic, the MACD will be less effective.
MACD is not good at providing stock tips, and cannot accurately tell you which are overbought or oversold. You can use it to look at stock market trends so that you have an idea of when it may be a good time to enter the market.