The Moving Average Convergence-Divergence (MACD) is a timing model, which was invented during the late 1970s by Gerald Appel, has become one of the most popular of technical tools, used by short- and longer-term investors in the stock, bond, and other investment markets. It is a featured indicator on virtually every computer-based technical trading program and trading platform. MACD is an indicator for all seasons. Many of us use MACD for simple crossovers or looking for Divergences but there are certain very significant supplementary additions to the basic rules relating to MACD buy/sell signals which Gerald Appel describes in his book Technical Analysis: Power Tools For Active Investors. These are as following:
• Buy signals are much more reliable when the MACD has crossed from above to below 0 at some time since the most recent sell signal. The MACD does not have to be below 0 at the time of the buy signal, but it should have been below 0 at some time since the start of the recent decline.
• Sell signals are more reliable when the MACD has crossed from below to above 0 at some time since the most recent buy signal. The MACD does not have to be above 0 at the time of the sell signal, but it should have been above 0 at some time since the start of the most recent advance.
• During very strong market periods, usually during the early and best stages of bull markets, the MACD will retreat during market reactions to a level just above 0. In this case, you can shade the previous rules a bit as you might if the MACD tops out just below 0 during a bear market or severe intermediate decline. Most often, however, the 0 crossing condition should be respected.
A very important rule, if there are no divergences – means that MACD lines and Price lines are moving in conjunction and trends of the markets are favorable with Price rising above its MA you can ignore the first sell signal generated by the MACD. YOU SHOULD HOWEVER TAKE THE SECOND SELL SIGNAL!!!
The above rules help you in setting procedures by which you can buy weakness and sell strength rather than buying and selling every change in minor trend and this also reduces the frequency of trading.
In addition to above Gerald Appel also advocates the following:
• You should maintain at least two MACD combinations: a faster one for buying and a slower one for selling.
• When market trends are very positive, buy very fast and sell very slow. You can employ the 6–19 combination for buying, or you can employ the somewhat more reliable 12–26 combination. The 19- to 39-day combination is used for selling.
• When market trends are neutral to somewhat positive, buy fast and sell slow. Use the 12–26 combination for buying. Use the 19–39 combination for selling.
• When market trends are clearly negative, buy fast and sell fast. You can use the 12–26 MACD combination for both buying and selling, in which case you will sometimes be selling before the slower-moving 19- to 39-day MACD has crossed from below to above 0. However, unless a stop-out takes place, the 12–26 MACD lines should generally rise above 0 as a precondition for a sell.
Hope this little write up is useful to friends who like me are avid users of MACD in their technical analysis. Some basic information on MACD can be found here.