MACD Divergence

The third cue, divergence, refers to a discrepancy between the MACD line and the graph of the stock price. Positive divergence between the MACD and price arises when price hits a new low, but the MACD doesn’t. This is interpreted as bullish, suggesting the downtrend may be nearly over. Negative divergence is when the stock price hits a new high but the MACD does not. This is interpreted as bearish, suggesting that recent price increases will not continue.

Divergence may also occur between the stock price and the histogram. If new high price levels are not confirmed by new high histogram levels, it is considered bearish; alternatively, if new low price levels are not confirmed by new low histogram levels, it is considered bullish.

Longer and sharper divergences—distinct peaks or troughs—are regarded as more significant than small, shallow patterns.


Timing

The MACD is only as useful as the context in which it is applied. An analyst might apply the MACD to a weekly scale before looking at a daily scale, in order to avoid making short term trades against the direction of the intermediate trend. Analysts will also vary the parameters of the MACD to track trends of varying duration. One popular short-term set-up, for example, is the (5,35,5).

False signals

Like any indicator, the MACD can generate false signals. A false positive, for example, would be a bullish crossover followed by a sudden decline in a stock. A false negative would be a situation where there was no bullish crossover, yet the stock accelerated suddenly upwards.

A prudent strategy would be to apply a filter to signal line crossovers to ensure that they will hold. An example of a price filter would be to buy if the MACD line breaks above the signal line and then remains above it for three days. As with any filtering strategy, this reduces the probability of false signals but increases the frequency of missed profit.

Analysts use a variety of approaches to filter out false signals and confirm true ones.

 

Continue to the next lesson – Is that the right time to sell?



*This guide is mainly based on wikipedia’s texts & images. We thank the authors. for their great efforts.