Investing + Trading

MACD Divergence And Crossover

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Trading Strategy
This is a guest post by Ahmad Hassam

First read the article on the Moving Average Convergence Divergence (MACD) to know what is the MACD black line and the signal or the trigger grey line and plus what is a MACD histogram. When the MACD line crosses above the signal line or the trigger line, this is known as the MACD cross or a Moving Average Crossover. When the MACD line is above the trigger line, it supports a long position and when the MACD line is below the trigger line, it supports a short position.

The crossover of the MACD line and the trigger line close to the zero line provides information whether the trigger is in the direction of the current trend. A cross of the black line below the gray line that occurs below the zero line is a sell signal in the direction of the current trend. Whereas the cross of the black line above the gray line below the zero line is a counter trend buy signal. When the black line crosses above the grey line above the zero line, it is a trend buy signal and when the black line crosses below the grey line above the zero line, it is a counter trend sell signal.

Another way to use MACD is to get signals called Divergence. A divergence occurs when the price is going in one direction and MACD is not confirming that direction. When the price action is making lower lows and the MACD is making higher lows, it is known as a Positive Divergence. Similarly, when price action is making higher lows and the MACD is making lower lows, it is known as a Negative Divergence.

You must keep this in mind that in a strong market, it is not uncommon to see a double or triple divergence before the market makes a correction or a trend reversal. Divergence over a shorter period of time as a rule of thumb is more powerful than divergence over a longer period of time.
Always think of a divergence as a development that indicates that the market needs to take a break. Although most market reversals exhibit divergence before they take a turn, markets also exhibit divergence just before normal consolidation periods.

There is also a divergence between the MACD histogram and the price that is as significant as the divergence between the MACD and the price action. The important question that comes to our mind is that which of the two divergences is more important. Short term divergence generally shows more early on the histogram and can be more significant.

First gauge the direction of the current trend on the price chart. Now look for the MACD to confirm that direction. Gauge the momentum of the trend with the histogram. The MACD histogram should be on the same side as the trade. As long as the momentum exists stay in the trade to let the profits run. If you get the MACD cross on the same timeframe that you took the signal, exit your position.

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