Friday, August 26, 2011

Technical Analysis Tools - MACD, Part I


For this series of posts, I will be discussing some of the most commonly used technical analysis tools in the swing trading community. There are an endless number of technical indicators on most technical analysis and trading websites and it can be mighty daunting to sort through them when you are getting your feet wet. So to start, I will focus on what I find most useful and later in the series I will delve into the more arcane ones.

When I first started trading, I was of the mind that the more indicators you use, the better. I could not have been further from the truth! Using too many indicators leads to confusion, frustration and a trip to the drugstore for some extra-strength Tylenol. Worst of all it can lead to trading paralysis along the lines of: "this indicator says to buy, this one says to sell, and the other ten say to do nothing! What should I do????" So my sage words of advice that I will pound into you (and myself) again and again is "Keep It Simple, Stupid". Find the three or four most trustworthy indicators you find after experimentation on a simulator and through backtesting and master them. You should choose ones that you find easy to understand and that will help you avoid Trader's Block. Using this approach will give you clarity, calmness and quiet confidence, all of which are totally necessary to being a successful trader.

As I write this series of posts, I will spare you the underlying mathematical equations in these indicators. Most successful traders do not know anything beyond the nuts-and-bolts nor do they need to. A good driver doesn't need to be a mechanic to steer his vehicle the right way. The basics work just fine.

Without further ado, I will start off with the Moving Average Convergence/Divergence, better known by its initials of MACD. The MACD consists of two plot lines on a stock chart that paints a picture of where stocks have been in both the short and long term. Since past is prologue in the stock market, I find it to be one of if not the most useful of tools when interpreted properly. The same way a meteorologist will track an existing hurricane by studying the pathways and tendencies of hurricanes throughout history in the hope they can predict its path, a studious trader will pore through his/her charts and look at how it has performed in the past to glean the stock's next big move. The MACD greatly aids in this endeavor. It helps a trader by indicating the strength of a given trend.

My next post will be a synopsis of the MACD and how it works. The third part will be the one you care to trade it properly.

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