Spotting trend reversals MACD- MACD divergences are considered one of the most powerful ways to trade with MACD. The idea of a divergence is the same with many other
oscillators (like RSI, Momentum, or Stochastics).
Many trading strategies are based on a process, not a single signal. This process often involves a series of steps that ultimately lead to a signal. Typically, chartists first establish a trading bias or long-term perspective. Second, chartists wait for pullbacks or bounces that will improve the risk-reward ratio. Third, chartists look for a reversal that indicates a subsequent upturn or downturn in price. Just like stock prices, momentum will trend. Momentum changes precede stock price changes. This article is designed to help you spot trend changes in momentum and stock price.
MACD (Moving Average Convergence/Divergence)
If there were ever a quest in the world of investing on par with the search for the Holy Grail, it would be acquiring the ability to spot trend changes. There are many ways investors attempt to do this with varying degrees of success, but a common trend-tracking tool is the two-line moving average convergence divergence (MACD).
MACD is built on exponential moving averages, which make many people immediately think about trend following, there are also ways to use the MACD for counter-trend trading and spotting probable reversals. This tool measures a stock’s momentum and can aid investors in spotting changes in market sentiment.
Trading overbought/oversold market with MACD
Thought officially the MACD indicator has nothing like overbought and oversold levels and the values it can reach are not limited by any certain number, it is possible to use the MACD for identifying when the market’s momentum may be overheated on one side or the other. However, it is quite difficult to define hard fixed rules for such strategy. Trading it successfully requires a good familiarity with the behaviour of the market you trade – especially knowing which MACD levels are usually too far away from the zero line and might therefore signal high probability of a pullback towards it (a correction in the current trend).