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A MACD chart is a prime example of this. Here, we look closer at what the graphs actually mean…. MACD was developed over four decades ago. Put simply, these indicator tools are still used widely today because they can give a useful snapshot visual representation of both momentum and trend.
Whereas trend is concerned almost exclusively with clearly quantifiable historical price data, momentum is concerned more with the bigger picture to try and determine the rate of change.
The big problem with momentum data is the inability to automatically put a figure on it. This is where oscillators come in: Their main purpose is generally to tell traders about a possible start of a new trend, or its reversal. Taking the form of lines drawn under the price chart for the stock, index or currency in question, their name comes from the fact that their values invariably oscillate in a certain range.
The MACD oscillator, with its inbuilt ability to plot the difference between moving price averages for several time periods, is especially useful at identifying divergences between the indicator and the short-term market price trend. A quick glance at the MACD reveals that it has stopped rising at a level that is lower than the previous line. The implication is that the upward trend is running out of momentum and that we could be about to see a downward trend.
The moving average is set to 9 by default. The MACD line oscillates above and below the zero line also known as the centreline. Generally, a buy signal bullish crossover happens when the MACD turns upwards and crosses the signal line. A bearish crossover occurs when the MACD turns down and crosses below the signal line. A possible bullish indicator here is where the MACD starts to advance and yet the security is losing value — or where the stock price records a lower low and the MACD forms a higher low.
Both of these are examples of positive divergence. On the other side, a bearish sign in the form of negative divergence occurs where the stock advances or moves sideways and the MACD maps a lower high or a decline. This could be a warning of a peak on the cards.
The MACD chart has a reputation of being one of the most reliable indicators around — but as with all indicators, is far from infallible. Look out for multiple signals and combine with other tools to integrate it into your strategy. Investopedia — Differences between momentum and trend.