One of the most commonly used tools in active trading is known as the moving average convergence divergence (MACD) indicator. Although the name of this indicator seems intimidating, it is actually quite simple to use and it can often generate profitable trading ideas.
As you can see from the chart below, the indicator consists of two parts: the MACD line and the signal line. The MACD line is simply the difference between two exponential moving averages, typically the 12-day and 26-day averages. The reason that traders pay attention to varying lengths of moving averages is because they want to figure out how the short-term momentum is changing relative to the longer-term momentum. If the short-term average falls faster than the long-term average, the MACD moves downward. Traders use this to suggests that the selling pressure is increasing.
The signal line, shown as the dotted blue line on the chart, is also known as a trigger line and is created by taking a nine-period moving average of the MACD line. The signal line is plotted alongside the MACD line and is used to predict changes in a stock's direction.
The most common sell sign is triggered when the MACD line crosses below the signal line (illustrated by the middle arrow in the chart above). A MACD cross below the signal line tends to predict that the bears are gaining control of the direction and it generally leads to a short-term move lower. Let's take a look at some stocks that have recently triggered a bearish MACD crossover:
AK Steel Holding Corporation (NYSE:AKS) - Taking a look at the chart of AKS, traders will notice that the price of the shares have recently broken out of a prolonged period of consolidation. Unfortunately for the bulls, the shares have pulled back toward the support of the 200-day moving average and now looks like it could be poised to head lower. Recent selling pressure has caused the MACD line to cross below the trigger line. This bearish crossover will be used by the bulls to confirm the downward momentum and they will likely add to the selling pressure if the price slips below the nearby moving average (around $14). A stop-loss order above the nearby pivot high is strategic because it will protect active traders from a move higher; it will also put them in a good position if the broad market weakness continues.
Flextronics International Ltd. (Nasdaq:FLEX) - FLEX is another company that has recently experienced a bearish MACD crossover. The stock has recently bounced off the resistance of the $8.50 level and a double top pattern has formed on the chart. Shares have also fallen below the support of the nearby 50-day moving average and appear to be ready to break below the bottom of the pattern, which could trigger stop losses and increase the downward pressure. You'll also notice that the stock broke below the 50-day moving average with high volume, which suggests that the pattern is stronger than some bulls are anticipating and that the short-term downtrend will likely remain dominant. (For more, see Analyzing Chart Patterns: Double Top)
Starbucks Corp. (Nasdaq:SBUX) - This stock has been on an incredible run over the past few months, but the recent MACD crossover is suggesting that the bears may be getting ready to step in. The stock is trading near its 52-week high and recent weakness is causing many bulls to question whether the uptrend will be able to continue.
SanDisk Inc. (Nasdaq:SNDK) - Taking a look at the daily chart of SanDisk, you'll notice that the recent upward momentum ran out of steam at its high of $53.60. This chart looks similar to that of FLEX because a double top pattern has formed. The bears appear to be trying to send the stock below the nearby support, which would trigger stop losses and increase the short-term selling pressure. The recent downward pressure has also coincided with a bearish MACD crossover so many bullish traders will want to keep an eye on this to see how the pattern develops.
In closing, it is important to note that the short-term nature of the MACD indicator can often lead to being whipsawed in and out of a position several times before being able to capture a strong price movement. This tool should be used in conjunction with other technical indicators to ensure a more accurate idea about a stock's direction. Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!