The moving average convergence/divergence (MACD) is a momentum indicator, and here, it's combined with pattern recognition to help you identify exit points for your system.
It takes more than a good entry
strategy to trade profitably.
Many traders have experienced
the exhilaration of being in a
winning trade. Some of those
same traders have also known
the disappointment of watch-ing
their profit turn into a loss
when prices change. Knowing
when to take profits is part of
good money management. The moving average convergence/
divergence (MACD) profit alert presented here is a
pattern that helps traders make profit-taking exit decisions in
both the stock and commodity markets.
THE VERSATILE MACD
Basically, the MACD is a momentum indicator that fluctuates
above and below a zero line. Its developer, Gerald Appel,
presented it as a trading method composed of two components.
The first is a solid line that represents the difference
between two exponentially smoothed moving averages, often
referred to as the MACD line. The second component, the
signal or trigger line, is a dotted line that is an exponentially
smoothed moving average value of the solid line. (See
sidebar “The MACD.”) The MACD trading method consists of
buying when the solid line crosses above its signal line and
either exiting and/or short selling when the solid line crosses below its signal line.
The original MACD method continues to be a favorite
among traders, useful in ways beyond the initial technique.
One alternative use is as a gauge of trend when both the solid and dotted lines remain above the zero line during uptrends or below the zero line during downtrends. Another is to identify divergences between the indicator and price prior to changes in trends.
I have found yet another use for the MACD, that of a profit-taking
alert and exit function based on a pattern made by the
relationship between the solid and dotted lines.