Indicators – Questions
1. What is MACD and how is it used?
The moving average convergence divergence (MACD) is a kind of oscillating indicator that can help traders quickly spot increasing short-term momentum.
An oscillating indicator is a technical analysis indicator that varies over time within a band (above and below a centerline; the MACD fluctuates above and below zero). It is both a trend-following and momentum indicator.
One basic MACD strategy is to look at which side of zero the MACD lines are on in the histogram below the chart. If the MACD lines are above zero for a sustained period of time, the stock is likely trending upwards. Conversely, if the MACD lines are below zero for a sustained period of time, the trend is likely down.2 Using this strategy, potential buy signals occur when the MACD moves above zero, and potential sell signals when it crosses below zero.
Signal line crossovers can also provide additional buy and sell signals. A MACD has two lines—a fast line and a slow line. A buy signal occurs when the fast line crosses through and above the slow line. A sell signal occurs when the fast line crosses through and below the slow line.
2. What is the difference between MACD and RSI?
The relative strength index (RSI) is another oscillating indicator but its movement is contained between zero and 100 so it provides different information than the MACD.
One way to interpret the RSI is by viewing the price as “overbought”—and due for a correction—when the indicator in the histogram is above 70, and viewing the price as oversold—and due for a bounce—when the indicator is below 30.
In a strong uptrend, the price will often reach 70 and beyond for sustained periods of time. For downtrends, the price can stay at 30 or below for a long time. While general overbought and oversold levels can be accurate occasionally, they may not provide the most timely signals for trend traders.
An alternative is to buy close to oversold conditions when the trend is up and place a short trade near an overbought condition in a downtrend.
For example, suppose the long-term trend of a stock is up. A buy signal occurs when the RSI moves below 50 and then back above it. Essentially, this means a pullback in price has occurred. So the trader buys once the pullback appears to have ended (according to the RSI) and the trend is resuming. The 50-levels are used because the RSI doesn’t typically reach 30 in an uptrend unless a potential reversal is underway. A short-trade signal occurs when the trend is down and the RSI moves above 50 and then back below it.
3. What is OBV and how is it used?
The on-balance volume (OBV) indicator measures cumulative buying and selling pressure by adding the volume on “up” days and subtracting volume on “down” days.
On-balance volume (OBV) takes a significant amount of volume information and compiles it into a single one-line indicator. The indicator measures cumulative buying and selling pressure by adding the volume on “up” days and subtracting volume on “down” days.
Ideally, the volume should confirm trends. A rising price should be accompanied by a rising OBV; a falling price should be accompanied by a falling OBV.
If OBV is rising and the price isn’t, it’s likely that the price will follow the OBV in the future and start rising. If the price is rising and OBV is flat-lining or falling, the price may be near a top. If the price is falling and OBV is flat-lining or rising, the price could be nearing a bottom.
MACD is an oscillator line which follows price movement and provides signals when it interacts with a Moving Average.
MACD is a trend-following and momentum-based indicator, whereas RSI is a purely momentum-based indicator.
The OBV is a volume-based indicator, which takes cumulative buying and selling pressure, and plots it along and against a moving average trendline.