Friday, November 30, 2007

Screening to Win: MACD (Moving Average Convergence / Divergence)

The overview below describes one of the common technical indicators – MACD and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.


Moving Average Convergence / Divergence Overview

The MACD indicator was originally developed by Gerald Appel, and is considered to be one of the most reliable center line oscillators. MACD is formed by taking two moving averages, and subtracting the longer timeframe moving average from the shorter. This creates a leading momentum oscillator from underlying moving average indicators which are lagging. Typically a 26 and 12 day EMA are used to form the standard MACD indicator. The selection of these periods appears to provide the best trade-off between the reliability and speed of the MACD signals.

MACD is a centered oscillator; it rises and falls below a Center Line which is the zero level. Generally, territory above the center line is deemed bullish, while the area below is considered bearish. Centered oscillators are useful for identifying strength and weakness, but not overbought or oversold extremes.

A Signal Line is created for the MACD indicator by plotting a 9 day EMA of the MACD values.
The HingeFire tool provides support to incorporate MACD in your creation of screens for stocks. Users can scan to determine if the MACD indicator is greater than or less than the Center Line or Signal Line, and also establish if the MACD value has just crossed above (JCA) or below (JCB) these thresholds.

How to use MACD in screening

Most investors use MACD to determine if the general trend is bullish or bearish for the stock. Conventionally levels above the centerline are generally considered bullish, and those below bearish. A similar situation holds for the signal line. However most investors are focused on when the MACD indicator crosses these levels indicating a change in trend. The existence of the indicator above or below these levels in itself is not viewed as conclusive regarding the trend for the stock. Most investors screen for bullish or bearish crossovers of the MACD indicator of the Center Line and/or Signal Line.

Bullish MACD Crossovers

One common bullish scenario is when the MACD indicator crosses above the Centerline (zero level). The HingeFire screener supports looking for these crossovers. A screen in late October found Abbott Labs (ABT) when the MACD indicator (blue line) crosses over the Center Line. This was shortly after Abbott also crossed the red signal line. Since this time ABT has continued to generally increase in price.
As shown above, another bullish indicator is when the MACD Indicator crosses the Signal Line. This event may lead or lag the crossing of the centerline. Many investors focus on signal line crossings to time their entry or exit points. Many times the cross above the signal line indicates a change in trend.

Conagra Inc. (CAG) recently reversed a downtrend when the MACD indicator (blue) rose above the Signal Line (red). This occurred while the MACD indicator was still well below the centerline, providing investors an early signal to take a long position. The HingeFire screener discovered this setup when screen for the MACD indicator JCA the signal line earlier this week.

Bearish MACD Crossovers

One common bearish indicator is when MACD crosses below the centerline. This confirms that the trend has shifted from bullish to bearish. The previous history of MACD on a chart many times serves to underline the intensity of a cross below the centerline. A situation where the indicator dives from a high positive level down below the centerline indicates sharp downside price momentum. Scenarios where the MACD wobbles below the center line after several recent crosses usually indicates less conviction in bearish potential.

Tennant Co (TNC) had its MACD cross below the Center Line today. Despite entering bearish territory, the deficit of impetus in the indicator as it retraces below zero demonstrates a lack of conviction in the signal. While the HingeFire stock screener has picked up this cross below the Center Line, many traders would review the chart and search for other MACD cross below opportunities. This underlines the point that a screener is a tool that is focused on providing potential candidates, it is important for investors to do additional fundamental and chart research when selecting their stocks.

When the MACD Indicator crosses below the Signal Line it is usually a start of a bearish trend. The HingeFire screener found AK Steel Holding Corp (AKS) in a scan of MACD just crossed below (JCB) the signal line in late October. As the chart demonstrates AKS has continued to drop in price since this crossover. Many investors view that a MACD cross below is a good indicator of the start of a bearish trend, while an additional cross below the centerline serves as confirmation.

Combining MACD Signals

Many investors utilize MACD by combining signals. Some will screen for a bullish condition of the indicator above the signal line and just crossing the centerline. This looks for the confirmation of a bullish trend. Others may look for bullish conditions when the MACD indicator is already above the centerline and has just crossed above the signal line.

Inversely, bearish MACD signals can be combined in a similar manner. Investors may look for setups where the indicator is already below the signal line and just crossed below the centerline; or scan for conditions where MACD is below the center line and just crossed below the signal.

MACD Summary

Many investors also review charts for divergence between MACD and price. This situation usually indicates a significant disconnect in the market, implying that the equity is mis-priced based on market action. Some followers of the MACD indicator also review stock charts for the level of the MACD indicator, searching for key levels such at 0.5, 1, -0.5, and 1, as a pointer for future price action.

However the usual focus for MACD is on the Center Line and Signal Line. When the indicator crosses over these levels it usual serves as an important signal about a change in momentum for a stock. The HingeFire tool can be used to screen for the following significant events for the MACD indicator:
  • Bullish Crossovers of the Centerline
  • Bullish Crossovers of the Signal Line
  • Bearish Crossovers of the Center Line
  • Bearish Crossovers of the Signal Line
  • Combinations of Bullish or Bearish MACD signals

Combining technical indicators such as Moving Average Convergence / Divergence indicator with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The MACD support in the HingeFire Stock Screener adds a powerful tool for determining the momentum in the market so you can enter or exit your investments at the correct time.