Tuesday June 26, 2007

Moving Average Convergence Divergence

The Moving Average Convergence Divergence first came to light during the sixties. It works by using the difference between two exponential moving averages in different periods, this is known as an Oscillator. A signal is when the Moving Average Convergence Divergence crosses the signal line which is calculated as a 9 day moving average of the Moving Average Convergence Divergence.

To get a trading signal we need to first see whether the price is trending. If the Moving Average indicator is flat or remains close to 0 the market is ranging & signals are unreliable so we shouldn’t trade. 

In a trending market we should go long when the Moving Average line crosses the signal from below & we should go short when the Moving Average line crosses the signal from above. Remember that Moving Average signals are a lot stronger if there is a divergence on the Moving Average line or a big swing above or below the zero line.

Chart courtesy of StockCharts.com

So unless there is a divergence don’t go long if the signal is above the zero line & don’t go short if the signal is below zero.

Moving Average is useful to determine whether a market is going up or down in addition to portending possible reversals in sentiment and direction.

Another valued signal occurs when the fast or shorter moving average crosses over the slow or longer moving average line.

The fast line crossing over and moving up signals a bullish move, while the fast line crossing down through the slow line is bearish.

This can occur on either side of the zero line but bearish signals above zero and bullish signals below zero may offer much stronger changes in overall sentiment and possible price reversal.

Chart courtesy of StockCharts.com

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