One of the most commonly used tools in active trading is known as the moving average convergence divergence (MACD) indicator. Although the name of this indicator seems intimidating, it is actually quite simple to use and it can often generate profitable trading ideas.
As you can see from the chart below, the indicator consists of two parts: the MACD line and the signal line. The MACD line is simply the difference between two exponential moving averages, typically the 12-day and 26-day averages. The reason that traders pay attention to varying lengths of moving averages is because they want to figure out how the short-term momentum is changing relative to the longer-term momentum. If the short-term average rises faster than the long-term average, the MACD moves upward. Traders use this to suggest that the buying pressure is increasing.
The signal line, shown as the dotted blue line on the chart, is also known as a trigger line and is created by taking a nine-period moving average of the MACD line. The signal line is plotted alongside the MACD line and is used to predict changes in a stock's direction.
The most common buy sign is triggered when the MACD line crosses above the signal line (illustrated by the right arrow in the chart above). A MACD cross above the signal line tends to predict that the bulls are gaining control of the direction and it generally leads to a short-term move higher. Interestingly, traders have been spotting bullish MACD crossovers on the charts of many semiconductor stocks. The bullish movement in the utility sector could be used by active traders to suggest that the economic recovery is on track and could be stronger than many of the pundits have been suggesting.
In the table below you will find a list of semiconductor stocks that trade under $10 and have recently experienced a MACD buy sign:
It is interesting from a technical perspective to see strong relative strength in the area of the small-cap semiconductor sector. The bullish MACD crossovers occurring on the charts of the above companies could suggest that the economic recovery is stronger than many traders may think it is. It is also important to note that the short-term nature of the MACD indicator can often lead to being whipsawed in and out of a position several times before being able to capture a strong price movement so be sure to use this tool in conjunction with other technical/fundamental indicators to ensure a more accurate idea about a stock or sectors direction.
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