Understanding MACD Divergence
By Ahmad Hassam on July 1, 2009
Interpreting a MACD divergence can be very useful in your trading. What does a MACD Divergence means? Just that the current price trend is running out of steam. It may not happen right away. But a MACD Divergence is a powerful hint that the market is changing. Spotting a MACD divergence correctly will only come after practice. It is easy to spot MACD crossovers and dramatic rises but not so a MACD divergence.
What you are looking for is when the price action and MACD do not agree. For example, if the price is making a series of higher highs and MACD is making a series of lower lows, something is wrong between the two.
MACD is seen as a sign that fewer and fewer traders are in the trend. No one is trading against the trend. Yet fewer and fewer traders are in the trend. Most probably the traders are getting nervous and slowly fading out of their trades.
The only traders in the trend are nervous and jittery. They want to exit. Most of them are likely to exit their trade at the first sign of trouble. As soon as the bears muster up enough guts to short. MACD is diverging from the bullish trend. The bulls will exit and the bears will take over.
There are two powerful keys in locating times when MACD divergence is likely to represent a reversal in price. This is exactly why MACD is so powerful. It takes time to setup but when it works, it often works well.
MACD divergence can be powerful when the price is at the double tops or double bottoms. You are making your trading plan based on the bounce or breakout of the support and resistance. At this point you spot MACD divergence. This is known as Exhaustion Pullback.
You should trade based on rejection reversal. What does this means? This means that the price action is running out of steam. This indicates that there are not enough committed traders to break the support and resistance (S&R). The price will reverse direction.
MACD is also used as an overbought/ oversold indicator. When you see that it has reached its overbought/ oversold range and the price action is turning normal, this is a signal that you should avoid trading at this time.
Dont think that it is overbought and everyone is buying. Dont confuse the overbought/ oversold MACD zones as trade opportunities. However, when the price reaches its extreme, you will see price exhaust and the MACD line drop back into normal zone.
It is also important to note that divergence can not only be found on the MACD line and the signal line, it can also be found on the histogram. These two situations along with your other technical indicators can provide excellent trading opportunities.
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