Patterns of Moving Average Convergence/Divergence (Macd) - How to USE it?

RELY ON THE PATTERNS       

Another method useful with the MACD indicator, and one that is more reliable for determining a trend reversal, is to identify the pattern called bullish convergence. This is where the market price itself makes a lower low from a previous low, but the underlying MACD pattern makes a higher low, as shown in Figure 3.10. This indicates that the second low is a weak, or “false,” bottom and can resort in a turnaround for a sharp price reversal. This is similar to stochastics; however, since it is developed from moving averages, the timing of the shorter-term versus the longer-term moving averages can delay such a signal. There is a high probability that MACD and stochastics work more so than other indicators with this pattern.

As you can see in Figure 3.10, which is a five-minute chart on Intel, the market made a lower low in the next trading session where the MACD histogram makes a higher low. Notice the HCD signal. Then as the price starts to appreciate, the MACD histogram triggers or confirms a long position with a zero-line crossover, and the progressively higher histogram bars confirm the positive momentum right into the close of the day. The MACD is a very useful tool as a confirming indicator once you have entered in a position, especially by following the histogram readings.

The MACD has the same principles as far as a sell signal with what is known as bearish divergence. This is where the market price itself makes a higher high from a previous high, but the underlying MACD crossover lines make a lower high. This indicates that the second high is a “weak” high and can resort to a turnaround for a lower price reversal. In Figure 3.11, a daily chart in the FX spot euro currency, the MACD histogram helps identify both bearish and bullish divergence patterns.

One other useful method in using MACD is to follow as stated the direction of the histogram bars to help confirm a turn or a change in trend. Figure 3.12 shows the price advance in the e-mini-S&P as the market closes in on a pivot point resistance level, and the market moves from a bullish condition as prices move higher or in an overbought state and the histogram readings start to expand over 300.

As the market price conditions change, as the close is below the open, and as the market makes the first lower closing low, especially near the pivot resistance line, the histogram bars start rolling down or making lower highs as well. In a weak or down-trending market, the bars should also be making lower highs; and in this case, they are confirming a sell signal from the change in market condition as well as the moving average crossover as prices trade under the moving average lines. This last example is what we will be going over in later chapters as we combine pivot point analysis with candle patterns.

SUMMARY

In conclusion, all oscillators, indicators, and most moving average studies will give confirmation when a market shifts direction; and knowing these signals will help you identify a trading opportunity. They also will help give you a clue when a market is in an extreme price condition, described as being overbought and oversold. Therefore, as a trader, you need something that gives you a better idea of entering a trade. The next few chapters will reveal ways by which you will learn how to identify shifts in momentum before looking at an indicator as confirmation. Impossible, you say? Well, there are certain patterns such as the high close doji, the jackhammer candle pattern, a low close doji, or the shooting star formation that, when up against a projected pivot support or resistance line, will alert you to a trade entry faster than using these traditional indicators. When I introduce you to the concept of using a pivot point moving average component as was used in Figure 3.12, then you will see how it is possible.