Market Environment – Momentum
When trading the financial markets it is important be able to evaluate the current market environment and have the capability to employ a trading tool that can reflect the current market environment. When market are accelerating investors can considered jumping on the train in an effort to catch the move while a security is advancing. Momentum is a key element toward finding a market that is poised to break out and will potentially continue to move in a specific direction. A strong guide which can assist in finding markets that are accelerating is the MACD (moving average convergence divergence) index.
The MACD (moving average convergence divergence index) created by Jerald Appel, evaluates the changes in two specific moving averages (the spread), and compares the change in the spread to the moving average of the difference (the moving average of the spread).
MACD Crossover
MACD Default
The standard used as the inputs for the moving average convergence divergence index are the 12-day moving average, the 26-day moving average and the 9-day moving average of the spread. Appel used these moving averages to designate a short term moving average (12-days) , and a medium term moving average (26-days) and a short term moving average of the difference (9-day moving average).
MACD Alterations
The default is very robust at recognizing specific changes in momentum, but investors can use either faster or slower inputs levels to evaluate changes in momentum. For example, a MACD that uses a 5-day moving average and a 10-day moving average to calculate the spread, and comparing that spread to the 5-day moving average of the spread, generates a much faster crossover indicator than the default as can be seen in the chart below. The fast MACD will reflect quicker changes in momentum, and alter a trader of a new market direction. Unfortunately, the smaller moving average will also generate many more false changes in market momentum, which need to be carefully evaluated.
MACD Crossover and Index
A simple way to use the MACD as a momentum indicator that generates purchase and sell signal is to use the MACD crossover. When the spread crosses above the 9-day moving average of the spread, a buy signal is generated. When the spread crosses below the 9-day moving average of the spread, a sell signal is created.
In addition to the crossover, traders can use the index created by the MACD to evaluate momentum. The MACD is created by just looking at the spread. When the spread moves from positive to negative, which is designated by the histogram at the bottom of the chart below, a buy signal is created. When the spread crosses from positive to negative a sell signal is created.
When examining the MACD index, investors can also look at the trajectory of the index to determine if the index is expanding, or contracting. Just because the MACD is positive (or negative) does not mean momentum is increasing or decreasing.
MACD technical analysis
The MACD can be used with multiple types of time frames, which include daily, weekly, monthly, and intra-day data. A weekly MACD will give investors a solid view of long term momentum, which can assist in the evaluation of a long term market move.
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