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Understanding the Stock Market

The purpose of this article is to provide you with invaluable insights into the Stock Market.

Today's Topic:
THE BIG MAC-D

Last week’s article discussed the importance of determining support and resistance levels. We talked about how these lines can be determined, and discussed some approaches to take when support or resistance is tested. Today’s article will build from that platform by discussing the
MACD (nicknamed the “MAC-D” by technicians).

MAC-D is an acronym for Moving Average Convergence Divergence. As stated in the name, the MACD functions by using moving averages to determine the momentum of a stock. This momentum helps to forecast whether or not we should be buying or selling. The indicator consists of three moving averages, but we are only going to be concerned with two of them. Mostly what we need to understand about the MACD is that when a shorter-term moving average crosses above or below a longer-term moving average, it indicates that the momentum of that stock has changed.

Using the following illustration, we will demonstrate how we can use the
MACD to make buying and selling decisions based upon the crossover of the MACD moving averages. You can see in the example that by following the MACD you would have profited 32% or $10 in 3 months.































In the same period of time a buy-and-hold approach would have gained approximately 10% or $3. Histogram bars were added to the
MACD by Thomas Aspray to help you determine when the crossovers occur and when momentum is sliding. These blue bars are a measurement of the distance between the two moving averages. If the blue bars are above the zero line (they look like mountains), it means that the faster moving average is above the slower moving average. When valleys appear in the histogram bars, it indicates that the faster moving average has dropped below the slower moving average. Use the histogram bars to help you see where the momentum is slowing or reversing, or in other words, when the mountain or valley starts to roll over and fall or rise. This will help you anticipate momentum changes.

Try using this indicator on the stocks in your portfolio and practice determining where the entry and exit points occur. This tool is one of the most widely used technical indicators, and can really increase the profitability on your positions.

Next time we will  talk about the stochastic and how it can be applied. We will also show how you can use both indicators together to determine your entry and exit points.

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