Question:
Which indicators are best for spotting positive and negative divergences?
Kumar from MACD, CA.
Answer:
Kumar, you asked me about indicator(s), but to keep this simple, I will discuss the indicator for spotting convergence/divergence in stock movement—the Moving Average Convergence/Divergence indicator (MACD).
The MACD relies on moving averages, which are lagging indicators, to produce “predictive” characteristics about trends. Often referred to as a “momentum” indicator, the purpose of the MACD is to define strength of movement either up or down. The most popular formula for the “standard” MACD is the difference between a security’s 26-day and 12-day Exponential Moving Averages (EMAs). A nine-day EMA of the MACD, called the “trigger line” is then plotted on top of the MACD, functioning as a trigger for buy and sell signals This formula is used in many popular technical analysis programs because it produces more reliable results, and the longer “frame” helps the trader avoid “whipsaws” in trading.
Now you know what it is, here is what it does. The MACD produces bullish signals and bearish signals, which emerge from the crossover. Closing prices form the moving averages. A bullish crossover occurs when MACD moves above its 9-day EMA (trigger line), and a bearish crossover occurs when MACD moves below its 9-day EMA (trigger line).
This is a simple explanation for a complicated formula, but the truth is you don’t need to know the formula; you only need to read the graph, and that is simple. As well, there are other momentum indicators you should become familiar with, such as the Stochastic indicator. Remember, the more information you have to select and confirm a potential trade, the great your edge for success.
Trade in the day; invest in your life …
