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 rises faster than the long-term average, the MACD moves upward. Traders use this to suggests that the buying 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 buy sign is triggered when the MACD line crosses above the signal line (illustrated by the right arrow in the chart above). A MACD cross above the signal line tends to predict that the bulls are gaining control of the direction and it generally leads to a short-term move higher. Let's take a look at some stocks that have recently triggered a MACD buy sign:
HJ Heinz Co. (NYSE:HNZ) - Taking a look at the daily chart of HNZ, you'll notice that the bulls were able to send the stock to a new 52-week high. The move above the nearby swing high (shown by the black line) was accompanied by heavy volume, which suggests that the breakout is valid and that there could be some upside remaining. Furthermore, you'll notice that the MACD line recently crossed above the trigger line (blue dotted line). This bullish crossover will be used by the bulls to confirm the upward momentum and they will likely protect their positions by placing a stop-loss below the nearby trendline. A stop-loss order below the nearby support is strategic because it will protect active traders from continued broad-market weakness; it will also put them in a good position if the markets rebound later in the week.
CF Industries Holdings Inc. (NYSE:CF) - CF is another company that has recently experienced a bullish MACD crossover. As you can see from the chart below, the stock has recently bounced off the support of an ascending trendline (black line) and it looks like the retracement is over. Analysts will likely view the recent MACD crossover as a catalyst that could cause the stock to move higher again. You'll also notice that the volume has been increasing lately, which suggests that the support is stronger than some bulls are anticipating and that the long-term uptrend is still dominant.
Lindsay Corporation. (NYSE:LNN) - This stock has been on an incredible run over the past several years and the recent MACD crossover is suggesting that it is not over yet. As you can see from the chart below, the stock has pulled back slightly since mid April, but downward momentum weakened as the price neared $95.75 (horizontal trendline). The MACD crossover may be used by traders to confirm the strength of the nearby horizontal trendline and could trigger the start of the next move higher.
Mastercard Incorporated (NYSE:MA) - Taking a look at the daily chart of Mastercard, you'll notice that the recent upward momentum was able to send the stock above its May high. Last week's surge sent the stock to a new all-time high and it also coincided with a bullish MACD crossover. Many traders are feeling that the move is getting overextended, but the MACD cross is suggesting that the upward momentum may not be over yet. Many bullish traders will be looking to protect their positions by placing a stop-loss below the nearby trendline. However, those who are less risk averse, or those with longer investment horizons, may want to place their stop orders below the 50-day or 200-day moving averages (blue and pink lines respectively).
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.
For educational articles on the MACD see:
A Primer On The MACD
Moving Average MACD Combo
Trading The MACD Divergence