onn ben-zvi's List: Trading

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• If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot.
• If MACD is negative and declining further, then the negative gap between the faster moving average (blue) and the slower moving average (red) is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.
• A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA

• MACD generates bullish signals from three main sources:  

   
   
  1. Positive Divergence
      
   
  2. Bullish Moving Average Crossover
      
   
  3. Bullish Centerline Crossover
• A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher Lows or a second Low that is higher than the previous Low. Positive Divergences are probably the least common of the three signals, but are usually the most reliable, and lead to the biggest moves.

• A Bullish Moving Average Crossover occurs when MACD moves above its 9-day EMA, or trigger line. Bullish Moving Average Crossovers are probably the most common signals and as such are the least reliable. If not used in conjunction with other technical analysis tools, these crossovers can lead to whipsaws and many false signals. Bullish Moving Average Crossovers are used occasionally to confirm a positive divergence. A positive divergence can be considered valid when a Bullish Moving Average Crossover occurs after the MACD Line makes its second "higher Low". 

    

   Sometimes it is prudent to apply a price filter to the Bullish Moving Average Crossover to ensure that it will hold. An example of a price filter would be to buy if MACD breaks above the 9-day EMA and remains above for three days. The buy signal would then commence at the end of the third day. 
• A Bullish Centerline Crossover occurs when MACD moves above the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive, or from bearish to bullish. After a Positive Divergence and Bullish Centerline Crossover, the Bullish Centerline Crossover can act as a confirmation signal. Of the three signals, moving average crossover are probably the second most common signals.
• Even though some traders may use only one of the above signals to form a buy or a sell signal, using a combination can generate more robust signals. In the Halliburton (HAL) example, all three bullish signals were present and the stock still advanced another 20%. The stock formed a lower Low at the end of February, but MACD formed a higher Low, thus creating a potential Positive Divergence. MACD then formed a Bullish Moving Average Crossover by moving above its 9-day EMA. And finally, MACD traded above zero to form a Bullish Centerline Crossover. At the time of the Bullish Centerline Crossover, the stock was trading at 32 1/4 and went above 40 immediately after that. In August, the stock traded above 50.

• One of the primary benefits of MACD is that it incorporates aspects of both momentum and trend in one indicator. As a trend-following indicator, it will not be wrong for very long. The use of moving averages ensures that the indicator will eventually follow the movements of the underlying security. By using Exponential Moving Averages (EMAs), as opposed to Simple Moving Averages (SMAs), some of the lag has been taken out. 

    

   As a momentum indicator, MACD has the ability to foreshadow moves in the underlying security. MACD divergences can be key factors in predicting a trend change. A Negative Divergence signals that bullish momentum is waning, and there could be a potential change in trend from bullish to bearish. This can serve as an alert for traders to take some profits in long positions, or for aggressive traders to consider initiating a short position. 

    

   MACD can be applied to daily, weekly or monthly charts. MACD represents the convergence and divergence of two moving averages. The standard setting for MACD is the difference between the 12 and 26-period EMA. However, any combination of moving averages can be used. The set of moving averages used in MACD can be tailored for each individual security. For weekly charts, a faster set of moving averages may be appropriate. For volatile stocks, slower moving averages may be needed to help smooth the data. Given that level of flexibility, each individual should adjust the MACD to suit his or her own trading style, objectives and risk tolerance. 

• One of the beneficial aspects of the MACD is also one of its drawbacks. Moving averages, be they simple, exponential or weighted, are lagging indicators. Even though MACD represents the difference between two moving averages, there can still be some lag in the indicator itself. This is more likely to be the case with weekly charts than daily charts. One solution to this problem is the use of the MACD-Histogram. 

    

   MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to identify levels that historically represent overbought and oversold levels, MACD does not have any upper or lower limits to bind its movement. MACD can continue to overextend beyond historical extremes. 

    

   MACD calculates the absolute difference between two moving averages and not the percentage difference. MACD is calculated by subtracting one moving average from the other. As a security increases in price, the difference (both positive and negative) between the two moving averages is destined to grow. This makes its difficult to compare MACD levels over a long period of time, especially for stocks that have grown exponentially. 

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• There is no stop running when trading spreads. It is not  possible to use stops in a spread trade. Because you are long in one market and  short in another, you have become invisible to and immune to "stop fishing."  
  

• The goal is to match two trading vehicles that are highly correlated, trading one long and the other short when the pair's price ratio diverges "x" number of standard deviations - "x" is optimized using historical data. If the pair reverts to its mean trend, a profit is made on one or both of the positions.