MACD Divergence Magic

As traders we are trying to find the the magic bullet that will guarantee us profits galore.  We try to time things exactly so we are able to ride the 150% gain in XYZ stock, so we may use candlesticks that tell us whether the stock is turning bullish pr bearish, or a moving average cross, or we combine 6 different indicators that tells us the same thing, and in the end tell us nothing.  For technical traders though, there are tools or in this case a tool that we can use that increases our chances.  After all the market is risk, there are winners and loser, but we can increase our probabilities if we can find a reliable signal or pattern.

The MACD (Moving Average Convergence Divergence) may be an effective tool to help with increasing the probabilities of a trade.  By no means is it magic, or have magic properties, but it does have some advantages if you are paying attention to it.

The most common use of the MACD is to use it when the signal lines cross over, but the MACD is just slow sometimes and can give false signals. So it can be a little unreliable in that way, but there is a pattern it produces that if a trader is paying attention can increase the odds of having a successful trade.

MACD divergence is just this pattern.  What it means for a bullish divergence is that the price on the chart makes a lower low but on the MACD it creates a higher high.  Divergence, bullish or bearish, doesn't happen very often but when it does it can be very effective as an entry point.

A few examples that recently had a bullish divergence was Disney,

Looking at Disney (DIS) the stock was in decline and made lower highs and lower lows from August to October.  The MACD reached a low in August, but it when the price it a bottom in October it created a higher low on the MACD signaling a divergence in the price.  The down trendline was also broken, when that happened DIS jumped 23% in one month and has gained 75% since.



Lets take a look at another stock in a different sector to show a bullish diveregence.
Mckesson (MCK) in the summer of last year while the US was down graded on its debt experienced a downturn with the rest of the market plunging 20% from its highs in May.

When the first deep low was made in August the MACD hit a bottom as well, but when price made a low in October the MACD was trending up and made a higher low and divergence in price, also when the price began up it broke the trendline.  The price moved up from there 22% in about a month.



During periods of market correction and pullback it is best to look at stocks that may have made lower lows while making  higher lows in their MACD's. 

Now the norm is to find a divergence like the ones above, but there is a variation you can use as well. The double bottom pattern is reliable on its own but add to it a divergence in the MACD it can help identify an ideal place for entry.  The difference between this divergence is that the price hits a support level equal to the previous low instead of creating a lower low.

Coke (KO)  had this happen to it in December 2011.  It created the first low in October then it climbed and the rally reversed and dropped to support again just below $32 creating the set up for a double bottom.  That is when the MACD created a higher low and jumped 8% in a month when it broke out and has since been on a very strong run.



I know in the title of this article I alluded to "magic" but what we need to do as traders is be aware of a patterns like this.  I find that sometimes that technical patterns can just sneak up on you if you're not paying attention you'll miss them.


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