V.15:4 (145-153): The Moving Average Convergence/Divergence by Mark Vakkur, M.D.

The Moving Average Convergence/Divergence by Mark Vakkur, M.D.

Here's a novel way of using the moving average convergence/divergence (MACD) histogram to generate buy and sell signals for stock and mutual fund traders. Not only that, included is a simple means of analyzing risk-adjusted trading system performance.

The moving average convergence/divergence indicator, developed by Gerald Appel, is constructed by taking the difference of two moving averages of the closing price — one short, one long. This difference is smoothed with a moving average, and a comparison is made between the difference and its own moving average. For example, first subtract the 26-period moving average from a 12-period moving average to generate the indicator, which can be plotted as a line. A rising MACD line tells us that the momentum of the market is rising, since the “faster,” shorter moving average is rising more quickly than the “slower,” longer moving average.

Next, obtain a moving average of the MACD line, called a signal line; a popular choice is a nine-period moving average. The traditional interpretation of this indicator is to buy when a rising MACD line crosses above its signal line, and to sell when it crosses below it.