Query-MACD and RSI

Dear Traderji and Members,

I have a query about MACD. when we see MA crossover we say the fast line should be above the slow MA. That is if we have 20 day MA and 50 day MA as long as 20 day MA is above the 50 MA the share is in positive territory. Now what is confusing me is MACD is the difference of two EMA. we would take for eg 26 and 14 day. now we would minus 26-14 and draw the macd for diff days. if this figure is +ve we have the macd above zero line or else below the zero line. Now is this not contradicting the MA crossover or am i understanding this wrong. As in this MACD would be above zero if 26(slow EMA) would be above 14( fast EMA).

Also we draw a 9 day MA of this MACD and if this crosses the MACD above the zero line it is a buy signal. i get this but what does this crossover mean. Can anyoe explain the logic behind this.

ALso i would like to know if the histograms are long this means the price will come back to normal. how big is overstretched.

Now that i know the rules i just want to understand the logic behind these indicators.

also if someone has the patience to explain me the logic behind RSI too. i think i know the rules but what does the formula arrive that.

Also if someone can tell me a book which also is simple to understand and explains the logic behind these indicators.

Thanks and looking forward to your replies


Regards
Rahul

The Moving Average Convergence Divergence charts, or MACD charts for short, are a technical indicator that is derived from the moving average.

The MACD charts are oscillating indicators, meaning that they move above and below a centerline or zero point. As with other oscillating and momentum indicators, a very high value indicates that the stock is overbought and will likely drop soon. Conversely, a consistently low value indicates that the stock is oversold and is likely to climb.

THE 12-DAY AND 26-DAY EMAS

The MACD charts are based on 3 exponential moving averages, or EMA. These averages can be of any period, though the most common combination, and the one we will focus on, are the 12-26-9 MACD charts.

There are 2 parts to the MACD. We will focus first on the first part, which is based on the stock's 12-Day and 26-Day EMA. The 12-Day EMA is the faster EMA while the 26-Day is slower.

The logic behind using a faster and slower EMA is that this can be used to gauge momentum. When the faster (in this case 12-Day) EMA is above the slower 26-Day EMA, the stock is in an uptrend, and vice versa. If the 12-Day EMA is increasing much faster than the 26-Day EMA, the uptrend is becoming stronger and more pronounced. Conversely, when the 12-Day EMA starts slowing down, and the 26-Day begins to near it, the stock movement's momentum is beginning to fade, indicating the end of the uptrend.

THE MACD LINE

The MACD charts use these 2 EMA by taking the difference between them and plotting a new line. Very often, this new line is depicted as a thick black line in the middle chart.

When the 12-Day and 26-Day EMA are at the same value, the MACD line is at zero. When the 12-Day EMA is higher than the 26-Day EMA, the MACD line will be in positive territory. The further the 12-Day EMA is from the 26-Day EMA, the further the MACD line is from its centerline or zero value.

THE 9-DAY EMA

This line on its own doesn't tell much more than a moving average. It becomes more useful when we take into account its 9-Day EMA. This is the third value when we talk of 12-26-9 MACD charts. Note that the 9-Day EMA is an EMA of the MACD line, not of the stock price. This EMA (the thin blue line alongside the MACD line) acts like a normal EMA and smoothes the MACD line.

The 9-Day EMA acts as a signal line or trigger line for the MACD. When the MACD line crosses above the 9-Day EMA from below, it indicates that the downtrend is over and a new uptrend is forming. Time to consider bullish strategies. Conversely, when the MACD line drops below its 9-Day EMA, a new downtrend is forming and its time to implement bearish strategies.

The MACD does a terrific job in identifying momentum.

You can read more about this at http://www.investopedia.com/articles/forex/05/MomentumMACD.asp

Just a query on this part. In the first part we say that a high value indicates that stock is overbought. Then we say that if a 12 day EMA is increasing much faster than the 26 day EMA the uptrend is becoming stronger. Wont this lead to the over bought situation too.

And thank you Traderji your reply was very well explained.

Thank you Traderji for such a elaborate explanation on MACD. This indicator can help a lot to take long positions. I usually deal in options and for it I fornd it very good. Your explanation has increased my wish to study/learn more about technical analysis.
Thanks once again.
Mfire

Traderji, Thanks for nice explaination....can you please give some more brief information about stochastic indicators ( fast stochastic, smoothen stochastic, slow stochastic indicators)

Can you please give more details on best indicators out of the following indicators with brief description?
MACD , Volume , RSI , Stochastic, MFI , Williams %R , ADX

Overbought does not necessarily mean that the stock will not move to higher levels.

Overbought is a loosly defined term that means that the particular security has moved up too much, too fast or beyond ones expectatation.

One technique uses an overbought condition to identify a breakout and go long in a security is called stochastic pop!

The "pop" comes about when the stochastic indicator goes above the 70 to 80 level. Instead of reversing, however, the stock keeps going and momentum continues to rise. "Stochastic pop" is actually a misnomer, since the pop is in the price, not the stochastic. The stochastic itself stays above 70 or 80, held there by the price moving up and staying high in its daily ranges.

SETUP CONDITIONS

To identify a stochastic pop setup when the following conditions occur:

1 Recent price action in a tight daily consolidation range
2 Daily average directional movement index (ADX) below 20 (preferably below 15)
3 Daily stochastic %K above 70 (preferably above 80) and rising
4 Weekly stochastic %K above 50 and rising
5 Stock breakout on above average volume, and
6 Bullish market conditions.

The stochastic pop is not new; trader and author Jake Bernstein wrote about this phenomenon years ago. The setup conditions added are refinements that increase the odds of success by requiring confirming signals from both the daily ADX and weekly stochastic signals.

Keep in mind, of course, that the past performance of this strategy is not an indication of future success. One can utilize this methodology using daily and weekly charts to trade equities.

Thank you Traderji for such a beautiful explanation on Stochastic Indicators

Thank you for your explanation.

RGds
Rahul

Hello,

I had another query. In one of the stocks I was seeing at 200 price levels it was showing a macd reading of 10( around 7-8 months back)and now it is at the same price levels and it is showing a MACD reading of 5. My question is when we say that the MACD is stretched.....how much is stretched. Does it differ from stock to stock...industry to industry.....cause in some stocks the reading goes up to 15 and 20 also. So what levels do we considered stretched or over bought.

Also it is fine when we say when the fast signal line( 9 day ema of the MACD) crosses the MACD above zero line it is a buy signal. I want to understand the logic behind this. What does it show. When we talk abt MA crossovers and MACD.....we buy when fast line is above the slow line as it shows recent market expectation is more now. Am i right. So I just wanted to know the logic behind 9 day crossover of the macd.

Rgds
Rahul

Rahul,

Could you mention the name of the stock you are reffering to so that I can have a look at the chart and give you my feedback!