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Trading the BSE with the ADX Stock Trading Library (MEMBERS ONLY) Please Redirect HereADX is an oscillator that fluctuates between 0 and 100. Even though the scale isfrom 0 to 100, readings above 60 are relatively rare. Low readings, below 20,indicate a weak trend and high readings, above 40, indicate a strong trend.The indicator does not grade the trend as bullish or bearish, but merely assessesthe strength of the current trend. A reading above 40 can indicate a strongdowntrend as well as a strong uptrend. First Some History J. Welles Wilder developed the Average Directional Index (ADX) in order to evaluate the strength of the current trend, be it up or down. Its important to determine whether the market is trending or trading (moving sideways), because certain indicators give more useful results depending on the market doing one or the other. In other words the ADX attempts to measure the strength of the direction the security is moving in.The reason we mention this is that many of our students get confused when firstintroduced to ADX and see the indicator rising as the trend goes down. A risingADX means a strong trend, whether it be bullish or bearish.In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. Abuy signal occurs when +DI moves above -DI and a sell signal when -DI movesabove the +DI. Be careful, though; when a security is in a trading range, thissystem may produce many whipsaws. As with most technical indicators, +DI/-DIcrosses should be used in conjunction with other aspects of technical analysis.Below is an hourly hart of the BSE Sensex showing +D crossed over above -Dand the Black Index line of the ADX indicator also crossing above a reading of 30(Thin blue line) indicating a strong trend.
Advanced MethodAs mentioned previously you should use the ADX in conjunction with other aspects oftechnical analysis.We like to use the ADX (14 setting) together with Bollinger Bands (20 setting).Below is the same hourly chart of the BSE Sensex, now with the Bollinger Bands drawn inand indications of where we like to normally enter and exit the market using this tradingstrategy:
Trading Rules: • Plot the Average Directional Index with a setting of 14 • Plot Bollinger Bands with a setting of 20 • Confirm a reading above 30 on the ADX - Green Index Line, also a cross up of +D over -D. • Enter on the first candle closing OUTSIDE the top Bollinger Band line after the ADX has signaled (Green arrow) • Exit on the first candle that closes below the top Bollinger Band line again (Red arrow) • Keep your stop tight below the last candle that closed on/below the middle Bollinger Band line.
Trading BSE Stocks with Moving AveragesMoving averages are one of the most popular and easy to use tools available tothe BSE Stockstechnical analyst. They smooth a data series and make it easierto spot trends, something that is especially helpful in volatile markets. They alsoform the building blocks for many other technical indicators and overlays.The two most popular types of moving averages are the Simple Moving Average(SMA) and the Exponential Moving Average (EMA). Simple Moving Average (SMA) A simple moving average is formed by computing the average (mean) price of a security over a specified number of periods. While it is possible to create moving averages from the Open, the High, and the Low data points, most moving averages are created using the closing price.Exponential Moving Average (EMA)In order to reduce the lag in simple moving averages, technicians often useexponential moving averages (also called exponentially weighted movingaverages). EMAs reduce the lag by applying more weight to recent pricesrelative to older prices. The weighting applied to the most recent price dependson the specified period of the moving average. The shorter the EMAs period, themore weight that will be applied to the most recent price.Simple Versus ExponentialFrom afar, it would appear that the difference between an exponential movingaverage and a simple moving average is minimal. For this example, which usesonly 20 trading days, the difference is minimal, but a difference nonetheless. The
exponential moving average is consistently closer to the actual price.By giving more weight to recent prices, the EMA reacts quicker than the SMAand remains closer to the actual price.Which is better?The simple moving average obviously has a lag, but the exponential moving averagemay be prone to quicker breaks. Some traders prefer to use exponential movingaverages for shorter time periods to capture changes quicker.Some investors prefer simple moving averages over long time periods to identify long-term trend changes.SMAs will be more sensitive and generate more signals. The EMA, which isgenerally more sensitive than the SMA, will also be likely to generate moresignals. However, there will also be an increase in the number of false signalsand whipsaws. Longer moving averages will move slower and generate fewersignals.There are many ways to trade using moving averages and we would like to showone way we like to trade with a moving average set at 200.Below is an hourly chart of the BSE Sensex with the Commodity ChannelIndex (CCI) set at 14, Bollinger Bands set at 20 and a 200 Simple MovingAverage (SMA). Always use longer time periods as this shows true trend and willkeep you out of market whipsaws and consolidation periods.
Trading Rules (Going Long): 1. Plot the Commodity Channel Index (CCI) indicator at 14 2. Plot a 200 Simple Moving Average (SMA) 3. Plot the Bollinger Band indicator set at 20. 4. Wait for close of price outside the top Bollinger Band line and above the 200 SMA and enter as show above (Enter) 5. Exit whenever price closes BELOW the top Bollinger Band. You could also enter another contract and exit when price retraces back to the middle Bollinger Band line. 6. Place your stop on the lower Bollinger Band line.ConclusionBecause moving averages follow the trend, they work best when a security is trending and are ineffectivewhen a security moves in a trading range. With this in mind, investors and traders should first identifysecurities that display some trending characteristics before attempting to analyze with moving averages. Thisprocess does not have to be a scientific examination. Usually, a simple visual assessment of the price chartcan determine if a security exhibits characteristics of trend.In its simplest form, a securitys price can be doing only one of three things: trending up, trending down ortrading in a range. An uptrend is established when a security forms a series of higher highs and higher lows.A downtrend is established when a security forms a series of lower lows and lower highs. A trading range isestablished if a security cannot establish an uptrend or downtrend. If a security is in a trading range, anuptrend is started when the upper boundary of the range is broken and a downtrend begins when the lowerboundary is broken.
Trading the BSE with the CCIThe Commodity Channel Index (CCI) measures the variation of a securitys pricefrom its statistical mean. High values show that the price is unusually highcompared to the average price, whereas low values indicate that the price isunusually low. 85% of the data points will fall between +100 and -100. The levels of +200/-200 may be considered extremes. However, the CCI is not bound by maximum or minimum values. Contrary to its name, the CCI can be used effectively on any type of security, not just commodities. Interpretation There are two basic methods of interpreting the CCI: one is divergence and the other is as an overbought/oversold indicator. • Bullish divergence occurs when price is making new lows while the CCI is rising. This classic divergence is usually followed by a correction in the price. Bullish divergence is the opposite of bearish divergence. • The CCI typically oscillates between 100. To use the CCI as an overbought/oversold indicator, readings above +100 imply an overbought condition (and a pending price correction) while readings below -100 imply an oversold condition (and a pending rally).Below is an hourly chart of the BSE Sensex with the Commodity Channel Indexset at 14 showing Bullish divergence:
Bullish divergence occurred from point A-B (the price was declining as the CCI wasadvancing).The market subsequently rallied. Note that this divergence occurred at extreme levels (i.e.below - 100) making it even more significant.Advanced Trading Method:In the hourly chart example of the same BSE Sensex below we have added BollingerBands set at 20 to help us with our exact entry point, possible target and exit point.
Trading Rules (Going Long): • Identify bullish divergence as shown in the first chart example. • Enter on the break of price above the top Bollinger Band line (Green arrow). • Your target is the first close of price below the top Bollinger Band line ( Red arrow) • Place your stop below the last candle to close below the middle Bollinger Band line.ConclusionAs with most trading indicators always use the CCI with other indicators likeBollinger Bands shown in the trading method above, to filter out price whipsawsand consolidation periods. Pivot points also work well with the CCI because bothmethods attempt to find turning points.
Trading BSE Stocks with the Stochastic OscillatorDeveloped by George C. Lane in the late 1950s, the Stochastic Oscillator is amomentum indicator that shows the location of the current close relative to thehigh/low range over a set number of periods.In this lesson we will show one very accurate stock trading method we likeusing the Stochastic Oscillator. First Some History Lane observed that as prices increase in an up trend, closing prices tend to be closer to the upper end of bars and in a down trend closing prices tend to be nearer the lower end of bars. Lane developed stochastics to discern the relationship between the closing price and the high and low of a bar. Typically used to identify overbought and oversold conditions the indicator consists of two lines: % K and %D.These two lines fluctuate in a vertical range between 0 and 100. Readingsabove 80 are considered overbought and readings below 20 are consideredoversold.Calculation14 is a popular number of periods for calculation:
A 14-day %K (14-period Stochastic Oscillator) would use the most recent close,the highest high over the last 14 days and the lowest low over the last 14 days.The number of periods will vary according to the sensitivity and the type ofsignals desired.
Slow versus Fast versus FullThere are three types of StochasticOscillators: Fast, Slow, and Full. The Fastand Full Stochastic is discussed later.For the purposes of this trading method wewill only be looking at the Slow StochasticOscillator.The driving force behind all three StochasticOscillators is %K (fast), which is found usingthe formula provided above.Below is a 1 hour chart of the BSE Sensex showing the stochastic settings forthis trading method:Be sure to set the slow stochastic oscillator to K period:15, D period 5 and MAperiod 5.Advanced
Look for bullish divergence between price and the stochastic oscillator as shownin the image below:A 1 hour chart of the BSE Sensex showing divergence and the stochasticoscillator at 14:Trading Rules (Going Long): • Identify stochastic divergence, in the image above this is represented by two lines, make sure price is on the move down (green line) and the stochastic oscillator moving up (yellow line) fromOVERSOLD conditions (blue arrow). • Enter the market when price breaks the area of resistance. • Place your stop below the lowest candle after divergence occured. • Place a trailing stop of 30 pips or depending on your style of trading you could also draw in Bollinger Band lines and wait for price to retrace to the middle Bollinger Band line as an exit signal.ConclusionReadings below 20 are considered oversold and readings above 80 are
considered overbought. However, a reading above 80 is not necessarily bearishor a reading below 20 bullish. A security can continue to rise after the StochasticOscillator has reached 80 and continue to fall after the Stochastic Oscillator hasreached 20.Some of the best signals occur when the oscillator moved from overboughtterritory back below 80 and from oversold territory back above 20 but as usual itis best to use the oscillator together with some other indicator as shown aboveto filter out whipsaws and false signals.Thank you for joining us in this stock trading method.The Indiadaytrading Team
A Different Type of Moving Average CrossVirtually every stock trader has dabbled with or experimentedwith some sort of moving average. What I want to introduce youto in this lesson is a different sort of moving average crossmethod, which I have found to be very good at identifying shortterm trend changes.As we know a moving average is normally plotted using the closeof a bar e.g. if you were plotting a 3 period moving average, thenyou would add the last three closes and divide the total by three toget a simple moving average.This is where I want you to think a little differently.I have always been an advocate of taking traditional thinking andchanging it around.What if you used the open instead of the close? What if you usedthe close of one period of a moving average and the open ofanother?First, most charting packages will allow you to use the open,high, low or close to plot a moving average.
In the example below of the daily Dow Jones, I have used a 5period exponential moving average of the close and a 6 periodexponential moving average of the open. As you can see itcatches the short term trend changes really nicely.
In the next example of the 1 hour EUR/USD, you can see that theclose/open combination worked really well.Of course you will go through periods of consolidation with anymarket and any moving average method you use will be whipsawed.To get around this you need some sort of filter or approach that helpsyou keep out of the low probability trades.You could use ADX, Stochastic or MACD to help filter the noisebut I also like to add a time frame.In the next example of the 4 hour GBP/USD you can see that onthe 24th September 04 at 4:00 there was a cross of the 5 periodexponential moving average of the close above the 6 periodexponential moving average of the open. This signal hasremained in place until today as I write on the 27th September.
Although there was a signal on the 4 hour, to help identify evenbetter entry points you can drop down a few time frames to the30 minute chart. As you can see from the 30 minute chart therehave been quite a few crosses of the 5 period exponentialmoving of the close above or below the 6 period exponentialmoving average of the open.There are lots of ways to trade this but a neat little trick is to waitfor the signal on a higher time frame and then drop down a fewtime frames and wait for a pullback. The first signal after thepullback on the lower time frame is normally a pretty good entrypoint e.g. If there were a cross up on the large time frame thendrop down to a lower time frame and wait for the market toretrace and then give another buy signal (cross up). Theopposite is true for short signals.
Once you get the signal on the shorter time frame depending onwhere support is you can usually place your first stop loss underthe nearest support area (valley). If the market begins to makeprogress you can move your stop so that it trails the market bymoving your stop to just under the most recent support area.In this lesson I have use an exponential moving average butexperiment with different types of average such as weighted,smoothed or simple. You can also experiment with differentlengths of moving average.
Trading BSE Stocks using TrendlinesTechnical analysis is built on the assumption that stock prices trend. TrendLines are an important tool in technical analysis for both trend identification andconfirmation. A trend line is a straight line that connects two or more price pointsand then extends into the future to act as a line of support or resistance.First Some HistoryUsing trend lines as a tool to technically analyze the markets has been around for a longtime and was originally also used by floor traders.They saw that prices can only go in three directions; up, down, and sideways. A long lineof past price ranges together gives you a pattern.There will be plenty of ups and downs along the line but you should still be able todiscern a general direction up, down, or sideways.How to draw a trend line.The first consideration when looking at any market is the direction of the long termtrend.Trendlines illustrate the direction of the market movement and provide a primaryconsideration in any analysis. Keeping in mind that the market can move inmorethan one direction the following applies when drawing a trend line:Uptrends consist of a series of successively higher highs and lows.
Drawing trendlines during an up trending market: The trendlines above havebeen drawn by connecting as many successive lows as possible (along thebottom of the price range). An up trending trendline represents major support forprices as long as it is not violated.Downtrends consist of a series of successively lower highs and lows.
Drawing trendlines in a down trending market: Down trending trendlines aredrawn by connecting as many successive highs as possible as shown above(along the top of the price range). A down trending trendline representsmajor resistance for prices as long as it is not violated.
Support and ResistanceAn important concept in the use of trendlines as mentioned above is that of support andresistance.A continued trend is based on underlying support for prices in the market, for whateverreason.Similarly, there is resistance to higher prices built into the market.The trendline is one way to capture and illustrate these zones of support and resistance.As long as the market stays within these zones of support and resistance, asshown by a trendline, the trend is sustained. Any penetration through a trendlinewarns of a possible change in trend. We may not know the reason behind such achange, but we do know that for some reason the support or resistance for amarket is changing.The general idea behind trading trendlines is to look for a break of the trend in theopposite direction.A perfect set up would be for the market to break through an established trendlineA-B as illustrated below. You could add Bollinger Bands and wait for price to alsobreak through the middle line of the Bollinger Band at Point C before placing yourtrade..Below is a 4 hour chart of the BSE Sensex:
AdvancedA more advanced method is to use the break of the trendline A-B as confirmationof the overall trend change, then wait for price to hit point C (Purple Arrow) andthen use the Commodity Channel Index (CCI) indicator to reaffirm the trade.Trading rules: • Wait for price to break the trendline A-B. • Place your trade when price hits the middle Bollinger Band line at Point C (Purple Arrow), but only if the CCI shows a cross above 100 as at Point E illustrated on the chart below. • Exit the trade when price hits the upper Bollinger Band line at Point D (Yellow Arrow). • Your stop is the first close of a candle below the lower Bollinger Band line.Daily chart of the BSE Sensex with the Commodity Channel Index indicator(CCI) set at 34:
ConclusionTrend lines can offer great insight, but if used improperly, they can also producefalse signals. Other items - such as horizontal support and resistance levels orpeak-and-trough analysis - should be employed to validate trend line breaks.While trend lines have become a very popular aspect of technical analysis, theyare merely one tool for establishing, analyzing, and confirming a trend.Trend lines should not be the final arbiter, but should serve merely as a warningthat a change in trend may be imminent. By using trend line breaks for warnings,investors and traders can pay closer attention to other confirming signals for apotential change in trend.
BSE Parabolic Stock Trading SystemThis particular technique has been around a long time and is stillwidely used by many stock trading analysts because of itsadaptability to most markets. HistoryThe parabolic time/price system was first introduced by J. WellesWilder Jr. in his book New Concepts In Technical TradingSystems. It is very often referred to as the SAR system meaningstop and reverse. This means when a stop is hit the systemreverses so it is permanently in the market.The actual point at which the system is reversed is calculated on a dailybasis (or whatever time period you are looking at) and the stop moved tocreate a new reverse point. The SAR point never backs up.In other words if you are long the market the SAR point will increaseevery day.The same is true for short positions. This is the time part of thesystem.The other important part of the system is the speed at which theSAR point moves. If the market is moving fast the SAR point willmove slowly at first and then increase as the market moveshigher, this is the price part of the system.The rate at which the system increases is called the accelerationfactor.It is beyond this lesson to give the exact calculation of theacceleration factor and it is not really necessary to know theformula as most charting services now incorporate the system intheir indicator range.Example of what SAR looks like:
So far so good. The system is simple to trade and is very visualso its easy to know when you should be short or long. If the SARpoint (dots) is above the market you should be short and if theyare below the market you should be long.Heres the problem! It doesnt perform very well in the markets Ihave tested it on nor do I know any traders who trade it as astand-alone system. Maybe in the markets of the past it wouldhave worked well but not so now. The problem is there is just toomuch whipsaw.Now you may be asking if there is too much whipsaw whymention the system at all? Good question and here are tworeasons I find a good use for the system.
Money Flow Index (MFI)and the BSEYou are going to love this lesson. MFI is based on Money Flow but thetwo are not the same. Money flow analysis is a volume weighted relativestrength index. It is effective for most markets selection because it givesa view of a stock markets essential strength or weakness. Normally,MFI shows the same trends as the price pattern; indicating that, in anuptrend, money is flowing into the market, and when prices fall, money isflowing out of the market.First Some HistoryThe Money Flow Index was developed by Laszlo Birinyi, Jr. as a real-timevariation on the On-Balance Volume indicator.Instead of using each day as a reference point (as OBV does), MFI analyzeseach trade.And instead of ignoring the price or the amount that the market is up ordown, MFI weights each trade by price.CalculationThe Money Flow Index requires a series of calculations. First, theperiods Typical Price is calculated.Next, Money Flow (not the Money Flow Index) is calculated bymultiplying the periods Typical Price by the volume.If todays Typical Price is greater than yesterdays Typical Price, it isconsidered Positive Money Flow. If todays price is less, it is consideredNegative Money Flow.Positive Money Flow is the sum of the Positive Money over the specifiednumber of periods. Negative Money Flow is the sum of the NegativeMoney over the specified number of periods.The Money Ratio is then calculated by dividing the Positive Money Flow
by the Negative Money Flow.Finally, the Money Flow Index is calculated using the Money Ratio.How to use the MFI indicatorPositive and negative divergences between price and the MFI can be used asbuy and sell signals respectively, for they often indicate the imminent reversal ofa trend.If price is falling, but positive money flow tends to be greater than negativemoney flow, then there is more volume associated with daily price rises thanwith the price drops.This suggests a weak downtrend that threatens to reverse as moneyflowing into the security is "stronger" than money flowing out of it.Chart example:The MFI line can now be compared with the price of any security on theBSE or other stock exchange like the New York Stock Exchange to lookfor divergence.Below is a day trading chart. This chart shows how the MFI line can beused as confirmation of a trend change. The line on the price chart(Point A to Point B) shows price moving down with Point B lower thanPoint A while the corresponding line on the MFI (Point C to Point D)shows the indicator moving up with Point D higher than Point C.
MFI Uptrend (Going long)One way to trade the MFI is to trade divergence between price and theMFI line. Below is a day trading chart with the MFI indicator set at 14and the Bollinger Band indicator set at 20.
Trading rules for going long (buy): • The MFI line (Point C to D) is rising while price is declining (Point A to B). • Enter on the first touch of price at the middle Bollinger Band line (Point E). • Your stop will be the first candle that closes below the lower Bollinger Band line. • Your target will be the first candle that closes above the upper Bollinger Band line (Point F).SummaryThe Money Flow Index (MFI) indicator shows positive and negativedivergences between itself and price and can be used as a buy signal asit often indicates the imminent reversal of a trend. If price is falling, butpositive money flow tends to be greater than negative money flow, thenthere is more volume associated with daily price rises than with the pricedrops. This suggests a weak downtrend that threatens to reverse asmoney flowing into the security is "stronger" than money flowing out of it.
India Stock Market CycleIn this lesson we are going to look at the different stages of atrend and how it can help you position yourself for a trade inany Stock market.It is commonly accepted that there are four stages of a trend.These stages make up a cycle and each cycle has smaller cyclescontained within them.It doesnt matter whether you like to trade with 5-minute charts ormonthly charts. Each market will be in some stage of the cycle asyou are observing it.Before you even think about getting into a trade you should havesome idea of where the market is in the cycle. This will help youavoid making the wrong entry. For example, if you have identifiedstage two of the cycle it doesnt make sense for you to be shortin an up stage.If you look at the chart below you can see the 4 different stagesclearly marked:
Stage OneThe start of the market cycle (stage one) is where there is verylittle happening and the market is generally flat. At this stage themarket is normally oscillating in a certain range.As this stage ends you often see a breakout of the previousrange. The breakout can often be explosive particularly if it hasbeen in consolidation for a long period of time.For markets that can measure volume an increase of volume isan early indication that the breakout is real.Stage TwoStage two is after the breakout has occurred and we begin tohead North. Depending on the force of the move the market mayrally and not come back to the breakout point or it may comeback and test that area.In the chart example the market broke out of the range and thenrallied to R1 where it began to retreat to S1. These two pointsare very important. If S1 were lower than the breakout point or
S1 were to rally slight but still remain below R1 then break backdown past S1 then the start of the cycle would be in doubt.What actually happened was that the market came down to S1 and thenrallied past R1.The aggressive trader would already have taken a position on thebreakout and most likely add to the position as R1 was taken.If you had not entered the market yet then this would be an idealopportunity to jump in.The second point to note is that the moving average began toturn up after the breakout giving further support to the beginningof the cycle.In the case of the chart example I have selected a simple 40period moving average of the closes. You can use any movingaverage that suits the time frame you are dealing in.Stage two continues making higher peaks and higher valleys andmay come back to test the moving average a few times.Stage ThreeStage three is the final thrust of the cycle. You may notice aspike or a double top formation as the trend begins to run out ofsteam.In our example the top is fairly flat. R2 is formed and the marketretreats to S2. What happens next is the opposite of the start ofthe cycle. The market stops at S2 and then rallies slightly. Thefact that the rally did not exceed R2 is what is significant. Insteadthe market only reached R3.As soon as the market broke through S2 it signified the end ofthe trend. You would also note that the moving average turneddown at this point further give support to the end of the up move.If the top was not easily identifiable and positions closed at thattime then once S2 was taken any long positions would havebeen closed.
Stage FourThis is the final stage of the cycle and perhaps the mostinteresting. Depending on market conditions some traders maynow go short. A potential shorting point would have been on thebreak of S2. The market in our example is making lower valleysand lower peaks. This tells us that there is now a move to thedownside.Before initiating a short on the break of S2 you could measurethe start of the whole move at the beginning of the cycle to wherethe market topped at stage three. You could then calculate the61.8% retracement (see lesson on Fibonacci). This would giveyou a downside target to aim for and if there was enough meatleft in the trade initiate a short trade.Stage four can be difficult as the market may either go intoconsolidation again or continue down.So how can this help your trading? Well, the first thing to dobefore you enter a trade is decide where in the cycle you are. Ifyou are at stage two then it could be dangerous to go short. Itcould also be dangerous to enter short if stage two had beenbuilding for a long time. Remember the market cant go up forever.On the other hand if we were entering stage four you wouldntwant to be long. Just by identifying the different stages of themarket it can help you lock in profits, make better judgmentsdecisions on whether you should be in the market at all andperhaps give you clues for entry and exits.
Trading BSE Stocks with MACDThe MACD is a trend-following momentum indicator that shows the relationshipbetween two moving averages of price. The MACD is calculated by subtractingthe 26-day exponential moving average (EMA) from the 12-day EMA. A nine-dayEMA of the MACD, called the "signal line", is then plotted on top of the MACD,functioning as a trigger for buy and sell signals.First Some HistoryDeveloped by Gerald Appel, Moving Average Convergence/Divergence (MACD) is oneof the simplest and most reliable indicators available. MACD uses moving averages,which are lagging indicators, to include some trend-following characteristics. Theselagging indicators are turned into a momentum oscillator by subtracting the longermoving average from the shorter moving average. The resulting plot forms a line thatoscillates above and below zero, without any upper or lower limits.Benefits of the MACDOne of the primary benefits of MACD is that it incorporates aspects of bothmomentum and trend in one indicator. As a trend-following indicator, it will not bewrong for very long.The use of moving averages ensures that the indicator will eventually follow themovements of the underlying security. By using exponential moving averages, asopposed to simple moving averages, some of the lag has been taken out.MACD SetupThe default settings for the MACD which we will use are:Slow moving average - 26 daysFast moving average - 12 daysSignal line - 9 day moving average of the difference between fast and slow.All moving averages are exponential.Although there are three moving averages mentioned you will only see two lines.The simplest method of use is when the two lines cross. If the faster signal linecrosses above the MACD line (The MACD line is calculated by the differencebetween the 26-day exponential moving average and the 12-day exponentialmoving average) then a buy signal is generated and vice versa.It is also used as an overbought and oversold indicator. The higher above thezero both lines are the more overbought it becomes and the lower below the zeroline both lines are the more oversold it becomes.
It may also lead to a stronger signal if the signal line crosses down when it is overboughtand crosses up when it is oversold. The last common use of MACD is that of divergence.If the MACD is making new lows and the price of the security is not making new lows thatis one form of divergence (bullish divergence). Also, if the MACD has made a high andstarts to head down but price continues up that is another type of divergence (bearishdivergence) and may lead to an indication of a change in direction. (but more on this laterin the course)...There are many ways to trade the MACD but one of our favourites are too usetwo different time frames. All you do is establish a trend in a higher time periodthan the one you intend to trade. For our higher time frame we like to use the 30min chart and then drop down to the 5 min chart when conditions have been meton the 30 min chart..As you can see from the 30 min chart example of the BSE Sensex below therewas a bullish market signal on 12th December 06. The chart below (red arrow)shows the MACD (red line)crossing over above the 9-day EMA (blue line)signalling the market is going long.The histogram represents the difference between MACD and its 9-day EMA. Thehistogram is positive when MACD is above its 9-day EMA and negative whenMACD is below its 9-day EMA.
After confirming the signal on the 30 min chart we then dropped to the lower timeframe 5 min chart of the BSE Sensex and bought the rallies where the redarrows show, confident to stay long (to buy) as long as our higher time periodMACD trend in the 30 min stayed intact. If the 30 min MACD signal line were tocross down we would have closed all long positions. The chart below (red arrow)shows the MACD (red line)crossing over above the 9-day EMA (blue line)signalling to go long(buy) the market or in other words the market is bullish.
ConclusionThe MACD is not particularly good for identifying overbought and oversold levelseven though it is possible to identify levels that historically represent overboughtand oversold levels. The MACD does not have any upper or lower limits to bindits movement and can continue to overextend beyond historical extremes.Also the MACD calculates the absolute difference between two moving averagesand not the percentage difference. The MACD is calculated by subtracting onemoving average from the other. As a security increases in price, the difference(both positive and negative) between the two moving averages is destined togrow. This makes its difficult to compare MACD levels over a long period of time,especially for stocks that have grown exponentially.Having said that the MACD still is and will always be one of the few indicatorsthat all traders love and use daily and in many ways it is like seeing an oldfamiliar friend you know you can rely on.