Short for Moving Average and Convergence Divergence, MACD is a popular momentum and trend-following indicator that was developed in by Gerald Appel. The indicator is centerd on the information of moving averages, making it a credible momentum filter and tool, which you can use while trading in the stock market. The indicator is designed in such a way that analysts can reveal changes in momentum, strength, trends and direction while analysing stock processes.
As a trader, you can use the various signals given by this indicator to predict the trends, momentum and changes of the stock prices. The MACD indicator generates different signals which you can use to predict the changes while learning how to read MACD charts. They are as under:
1. The MACD Hook
The MACD hook occurs or materializes when the signal line tries penetrating or succeeds in penetrating the MACD line, turning at the last movements. This means that the hook happens when the signal and MACD lines touch each other, without crossing. The MACD hook primarily identifies the moves that are going against the trend, i.e. counter-trend within trending markets. The hook can become helpful for trading to purchase pullback during an uptrend and sell them during a downtrend. It also assists traders in identifying potential trade setups, making it quite a useful tool. As a trader, if you wish to enter a position, you should wait for the hook to materialize and confirm that the trend has indeed changed.
2. The hidden divergence
The hidden divergence is the second thing you should know about how to use MACD. When the stock price moves in one direction (whether it is up or down), while the indicator moves in another direction simultaneously; it can be said that divergence has occurred. In simple words, hidden divergence is the exact opposite of divergence and is referred to in the context of bullish and bearish divergence formations. The bullish divergence is formed when the current low of the rate or price exceeds the previous swing low, causing the MACD line to create an opposite pattern. The Bearish divergence, on the other hand, is the stark opposite of the bullish divergence. It occurs when the rate or price starts moving in the down-trend and makes higher highs as well as lower high patterns, with the MACD making an opposite pattern.
3. The histogram squeeze
The final thing you should know about how to use MACD is the histogram squeeze. When the price range of the stock starts getting tight and small at a time when the market volatility is low; the chances of explosive breakouts can increase manifolds. As a trader, you can spot the MACD Histogram and identify that the explosive breakout trends are imminent, and may occur anytime soon. However, to find out about an impending breaking, you should first check and ensure that the price comes into a small range. Also, remember that at this point, you should know how to read MACD histogram, which should look flat. You can begin the trade at the time when the price of the stock breaks the small range, while the histogram expands at the same time.