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 declines 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 trigger line is plotted alongside the MACD line and is used to predict changes in a stock's direction.
The most common signal used to predict a move lower is triggered when the MACD line crosses below the signal line (illustrated by the left 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 MACD sell sign:
Red Hat Inc. (NYSE:RHT) - Taking a look at the daily chart of RHT, you'll notice that the bears have sent the price below a short-term ascending trendline. The move below the support level was accompanied by a bearish MACD crossover, which will be used by traders to confirm a move lower. It is also important to note that many active traders will be keeping a close eye on this stock because the recent spike in volume suggests that the breakdown is valid and that there could be further downside to come.
TradeStation Group Inc. (Nasdaq:TRAD) - The chart of TRAD is very similar to the one above because the bears were able to send the stock below the support of an ascending trendline. As you can see below, the move lower also triggered a bearish MACD crossover, which will be used by traders to predict that the recent weakness could continue. It is also important to note that the stock bounced off the nearby resistance of its 200-day moving average (pink line), which is a common technical sign that the bears are in control of the longer-term direction. The combination of the different sell signals near the 200-day moving average suggests that it is a stronger area of resistance than many bulls were hoping it would be.
Texas Instruments Inc. (NYSE:TXN) - TXN is another company that has recently experienced a bearish MACD crossover. As you can see from the chart below, the bears have prevented the price action from moving above the $33 level, which is causing many traders to question whether rally will be able to continue. Many active traders will likely keep a close eye on this stock because it is currently testing an influential level of support, which if the price moves below would signal a drop toward the support of the lower trendline (currently near $30).
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