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4. Trading the BSE with the ADX
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ADX is an oscillator that fluctuates between 0 and 100. Even though the scale is
from 0 to 100, readings above 60 are relatively rare. Low readings, below 20,
indicate a weak trend and high readings, above 40, indicate a strong trend.
The indicator does not grade the trend as bullish or bearish, but merely assesses
the strength of the current trend. A reading above 40 can indicate a strong
downtrend as well as a strong uptrend.
First Some History
J. Welles Wilder developed the Average
Directional Index (ADX) in order to evaluate
the strength of the current trend, be it up or
down. It's important to determine whether the
market is trending or trading (moving
sideways), because certain indicators give
more useful results depending on the market
doing one or the other.
In other words the ADX attempts to measure
the strength of the direction the security is
moving in.
The reason we mention this is that many of our students get confused when first
introduced to ADX and see the indicator rising as the trend goes down. A rising
ADX means a strong trend, whether it be bullish or bearish.
In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A
buy signal occurs when +DI moves above -DI and a sell signal when -DI moves
above the +DI. Be careful, though; when a security is in a trading range, this
system may produce many whipsaws. As with most technical indicators, +DI/-DI
crosses should be used in conjunction with other aspects of technical analysis.
Below is an hourly hart of the BSE Sensex showing +D crossed over above -D
and the Black Index line of the ADX indicator also crossing above a reading of 30
(Thin blue line) indicating a strong trend.

5. Advanced Method
As mentioned previously you should use the ADX in conjunction with other aspects of
technical analysis.
We like to use the ADX (14 setting) together with Bollinger Bands (20 setting).
Below is the same hourly chart of the BSE Sensex, now with the Bollinger Bands drawn in
and indications of where we like to normally enter and exit the market using this trading
strategy:

6. Trading Rules:
• Plot the Average Directional Index with a setting of 14
• Plot Bollinger Bands with a setting of 20
• Confirm a reading above 30 on the ADX - Green Index Line, also a cross up
of +D over -D.
• Enter on the first candle closing OUTSIDE the top Bollinger Band line after
the ADX has signaled (Green arrow)
• Exit on the first candle that closes below the top Bollinger Band line again
(Red arrow)
• Keep your stop tight below the last candle that closed on/below the middle
Bollinger Band line.

7. Trading BSE Stocks with Moving Averages
Moving averages are one of the most popular and easy to use tools available to
the BSE Stockstechnical analyst. They smooth a data series and make it easier
to spot trends, something that is especially helpful in volatile markets. They also
form the building blocks for many other technical indicators and overlays.
The two most popular types of moving averages are the Simple Moving Average
(SMA) and the Exponential Moving Average (EMA).
Simple Moving Average (SMA)
A simple moving average is formed by
computing the average (mean) price of a
security over a specified number of periods.
While it is possible to create moving
averages from the Open, the High, and the
Low data points, most moving averages are
created using the closing price.
Exponential Moving Average (EMA)
In order to reduce the lag in simple moving averages, technicians often use
exponential moving averages (also called exponentially weighted moving
averages). EMA's reduce the lag by applying more weight to recent prices
relative to older prices. The weighting applied to the most recent price depends
on the specified period of the moving average. The shorter the EMA's period, the
more weight that will be applied to the most recent price.
Simple Versus Exponential
From afar, it would appear that the difference between an exponential moving
average and a simple moving average is minimal. For this example, which uses
only 20 trading days, the difference is minimal, but a difference nonetheless. The

8. exponential moving average is consistently closer to the actual price.
By giving more weight to recent prices, the EMA reacts quicker than the SMA
and remains closer to the actual price.
Which is better?
The simple moving average obviously has a lag, but the exponential moving average
may be prone to quicker breaks. Some traders prefer to use exponential moving
averages for shorter time periods to capture changes quicker.
Some investors prefer simple moving averages over long time periods to identify long-
term trend changes.
SMA's will be more sensitive and generate more signals. The EMA, which is
generally more sensitive than the SMA, will also be likely to generate more
signals. However, there will also be an increase in the number of false signals
and whipsaws. Longer moving averages will move slower and generate fewer
signals.
There are many ways to trade using moving averages and we would like to show
one way we like to trade with a moving average set at 200.
Below is an hourly chart of the BSE Sensex with the Commodity Channel
Index (CCI) set at 14, Bollinger Bands set at 20 and a 200 Simple Moving
Average (SMA). Always use longer time periods as this shows true trend and will
keep you out of market whipsaws and consolidation periods.

9. Trading Rules (Going Long):
1. Plot the Commodity Channel Index (CCI) indicator at 14
2. Plot a 200 Simple Moving Average (SMA)
3. Plot the Bollinger Band indicator set at 20.
4. Wait for close of price outside the top Bollinger Band line and above the 200 SMA
and enter as show above (Enter)
5. Exit whenever price closes BELOW the top Bollinger Band. You could also enter
another contract and exit when price retraces back to the middle Bollinger Band
line.
6. Place your stop on the lower Bollinger Band line.
Conclusion
Because moving averages follow the trend, they work best when a security is trending and are ineffective
when a security moves in a trading range. With this in mind, investors and traders should first identify
securities that display some trending characteristics before attempting to analyze with moving averages. This
process does not have to be a scientific examination. Usually, a simple visual assessment of the price chart
can determine if a security exhibits characteristics of trend.
In its simplest form, a security's price can be doing only one of three things: trending up, trending down or
trading in a range. An uptrend is established when a security forms a series of higher highs and higher lows.
A downtrend is established when a security forms a series of lower lows and lower highs. A trading range is
established if a security cannot establish an uptrend or downtrend. If a security is in a trading range, an
uptrend is started when the upper boundary of the range is broken and a downtrend begins when the lower
boundary is broken.

10. Trading the BSE with the CCI
The Commodity Channel Index (CCI) measures the variation of a security's price
from its statistical mean. High values show that the price is unusually high
compared to the average price, whereas low values indicate that the price is
unusually low.
85% of the data points will fall between +100
and -100. The levels of +200/-200 may be
considered extremes. However, the CCI is
not bound by maximum or minimum values.
Contrary to its name, the CCI can be used
effectively on any type of security, not just
commodities.
Interpretation
There are two basic methods of interpreting
the CCI: one is divergence and the other is
as an overbought/oversold indicator.
• Bullish divergence occurs when price is making new lows while the CCI is
rising. This classic divergence is usually followed by a correction in the price.
Bullish divergence is the opposite of bearish divergence.
• The CCI typically oscillates between 100. To use the CCI as an
overbought/oversold indicator, readings above +100 imply an overbought
condition (and a pending price correction) while readings below -100 imply
an oversold condition (and a pending rally).
Below is an hourly chart of the BSE Sensex with the Commodity Channel Index
set at 14 showing Bullish divergence:

11. Bullish divergence occurred from point A-B (the price was declining as the CCI was
advancing).
The market subsequently rallied. Note that this divergence occurred at extreme levels (i.e.
below - 100) making it even more significant.
Advanced Trading Method:
In the hourly chart example of the same BSE Sensex below we have added Bollinger
Bands set at 20 to help us with our exact entry point, possible target and exit point.

12. Trading Rules (Going Long):
• Identify bullish divergence as shown in the first chart example.
• Enter on the break of price above the top Bollinger Band line (Green arrow).
• Your target is the first close of price below the top Bollinger Band line ( Red
arrow)
• Place your stop below the last candle to close below the middle Bollinger
Band line.
Conclusion
As with most trading indicators always use the CCI with other indicators like
Bollinger Bands shown in the trading method above, to filter out price whipsaws
and consolidation periods. Pivot points also work well with the CCI because both
methods attempt to find turning points.

13. Trading BSE Stocks with the Stochastic
Oscillator
Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a
momentum indicator that shows the location of the current close relative to the
high/low range over a set number of periods.
In this lesson we will show one very accurate stock trading method we like
using the Stochastic Oscillator.
First Some History
Lane observed that as prices increase in an
up trend, closing prices tend to be closer to
the upper end of bars and in a down trend
closing prices tend to be nearer the lower
end of bars. Lane developed stochastics to
discern the relationship between the
closing price and the high and low of a bar.
Typically used to identify overbought and
oversold conditions the indicator consists of
two lines: % K and %D.
These two lines fluctuate in a vertical range between 0 and 100. Readings
above 80 are considered overbought and readings below 20 are considered
oversold.
Calculation
14 is a popular number of periods for calculation:

14. A 14-day %K (14-period Stochastic Oscillator) would use the most recent close,
the highest high over the last 14 days and the lowest low over the last 14 days.
The number of periods will vary according to the sensitivity and the type of
signals desired.

15. Slow versus Fast versus Full
There are three types of Stochastic
Oscillators: Fast, Slow, and Full. The Fast
and Full Stochastic is discussed later.
For the purposes of this trading method we
will only be looking at the Slow Stochastic
Oscillator.
The driving force behind all three Stochastic
Oscillators is %K (fast), which is found using
the formula provided above.
Below is a 1 hour chart of the BSE Sensex showing the stochastic settings for
this trading method:
Be sure to set the slow stochastic oscillator to K period:15, D period 5 and MA
period 5.
Advanced

16. Look for bullish divergence between price and the stochastic oscillator as shown
in the image below:
A 1 hour chart of the BSE Sensex showing divergence and the stochastic
oscillator at 14:
Trading Rules (Going Long):
• Identify stochastic divergence, in the image above this is represented by
two lines, make sure price is on the move down (green line) and the
stochastic oscillator moving up (yellow line) fromOVERSOLD conditions
(blue arrow).
• Enter the market when price breaks the area of resistance.
• Place your stop below the lowest candle after divergence occured.
• Place a trailing stop of 30 pips or depending on your style of trading you
could also draw in Bollinger Band lines and wait for price to retrace to the
middle Bollinger Band line as an exit signal.
Conclusion
Readings below 20 are considered oversold and readings above 80 are

17. considered overbought. However, a reading above 80 is not necessarily bearish
or a reading below 20 bullish. A security can continue to rise after the Stochastic
Oscillator has reached 80 and continue to fall after the Stochastic Oscillator has
reached 20.
Some of the best signals occur when the oscillator moved from overbought
territory back below 80 and from oversold territory back above 20 but as usual it
is best to use the oscillator together with some other indicator as shown above
to filter out whipsaws and false signals.
Thank you for joining us in this stock trading method.
The Indiadaytrading Team

18. A Different Type of Moving
Average Cross
Virtually every stock trader has dabbled with or experimented
with some sort of moving average. What I want to introduce you
to in this lesson is a different sort of moving average cross
method, which I have found to be very good at identifying short
term trend changes.
As we know a moving average is normally plotted using the close
of a bar e.g. if you were plotting a 3 period moving average, then
you would add the last three closes and divide the total by three to
get a simple moving average.
This is where I want you to think a little differently.
I have always been an advocate of taking traditional thinking and
changing it around.
What if you used the open instead of the close? What if you used
the close of one period of a moving average and the open of
another?
First, most charting packages will allow you to use the open,
high, low or close to plot a moving average.

19. In the example below of the daily Dow Jones, I have used a 5
period exponential moving average of the close and a 6 period
exponential moving average of the open. As you can see it
catches the short term trend changes really nicely.

20. In the next example of the 1 hour EUR/USD, you can see that the
close/open combination worked really well.
Of course you will go through periods of consolidation with any
market and any moving average method you use will be whipsawed.
To get around this you need some sort of filter or approach that helps
you keep out of the low probability trades.
You could use ADX, Stochastic or MACD to help filter the noise
but I also like to add a time frame.
In the next example of the 4 hour GBP/USD you can see that on
the 24th September 04 at 4:00 there was a cross of the 5 period
exponential moving average of the close above the 6 period
exponential moving average of the open. This signal has
remained in place until today as I write on the 27th September.

21. Although there was a signal on the 4 hour, to help identify even
better entry points you can drop down a few time frames to the
30 minute chart. As you can see from the 30 minute chart there
have been quite a few crosses of the 5 period exponential
moving of the close above or below the 6 period exponential
moving average of the open.
There are lots of ways to trade this but a neat little trick is to wait
for the signal on a higher time frame and then drop down a few
time frames and wait for a pullback. The first signal after the
pullback on the lower time frame is normally a pretty good entry
point e.g. If there were a cross up on the large time frame then
drop down to a lower time frame and wait for the market to
retrace and then give another buy signal (cross up). The
opposite is true for short signals.

22. Once you get the signal on the shorter time frame depending on
where support is you can usually place your first stop loss under
the nearest support area (valley). If the market begins to make
progress you can move your stop so that it trails the market by
moving your stop to just under the most recent support area.
In this lesson I have use an exponential moving average but
experiment with different types of average such as weighted,
smoothed or simple. You can also experiment with different
lengths of moving average.

23. Trading BSE Stocks using Trendlines
Technical analysis is built on the assumption that stock prices trend. Trend
Lines are an important tool in technical analysis for both trend identification and
confirmation. A trend line is a straight line that connects two or more price points
and then extends into the future to act as a line of support or resistance.
First Some History
Using trend lines as a tool to technically analyze the markets has been around for a long
time and was originally also used by floor traders.
They saw that prices can only go in three directions; up, down, and sideways. A long line
of past price ranges together gives you a pattern.
There will be plenty of ups and downs along the line but you should still be able to
discern a general direction up, down, or sideways.
How to draw a trend line.
The first consideration when looking at any market is the direction of the long term
trend.
Trendlines illustrate the direction of the market movement and provide a primary
consideration in any analysis. Keeping in mind that the market can move inmore
than one direction the following applies when drawing a trend line:
Uptrends consist of a series of successively higher highs and lows.

24. Drawing trendlines during an up trending market: The trendlines above have
been drawn by connecting as many successive lows as possible (along the
bottom of the price range). An up trending trendline represents major support for
prices as long as it is not violated.
Downtrends consist of a series of successively lower highs and lows.

25. Drawing trendlines in a down trending market: Down trending trendlines are
drawn by connecting as many successive highs as possible as shown above
(along the top of the price range). A down trending trendline represents
major resistance for prices as long as it is not violated.

26. Support and Resistance
An important concept in the use of trendlines as mentioned above is that of support and
resistance.
A continued trend is based on underlying support for prices in the market, for whatever
reason.
Similarly, there is resistance to higher prices built into the market.
The trendline is one way to capture and illustrate these zones of support and resistance.
As long as the market stays within these zones of support and resistance, as
shown by a trendline, the trend is sustained. Any penetration through a trendline
warns of a possible change in trend. We may not know the reason behind such a
change, but we do know that for some reason the support or resistance for a
market is changing.
The general idea behind trading trendlines is to look for a break of the trend in the
opposite direction.
A perfect set up would be for the market to break through an established trendline
A-B as illustrated below. You could add Bollinger Bands and wait for price to also
break through the middle line of the Bollinger Band at Point C before placing your
trade..
Below is a 4 hour chart of the BSE Sensex:

27. Advanced
A more advanced method is to use the break of the trendline A-B as confirmation
of the overall trend change, then wait for price to hit point C (Purple Arrow) and
then use the Commodity Channel Index (CCI) indicator to reaffirm the trade.
Trading rules:
• Wait for price to break the trendline A-B.
• Place your trade when price hits the middle Bollinger Band line at Point C
(Purple Arrow), but only if the CCI shows a cross above 100 as at Point E
illustrated on the chart below.
• Exit the trade when price hits the upper Bollinger Band line at Point D
(Yellow Arrow).
• Your stop is the first close of a candle below the lower Bollinger Band line.
Daily chart of the BSE Sensex with the Commodity Channel Index indicator
(CCI) set at 34:

28. Conclusion
Trend lines can offer great insight, but if used improperly, they can also produce
false signals. Other items - such as horizontal support and resistance levels or
peak-and-trough analysis - should be employed to validate trend line breaks.
While trend lines have become a very popular aspect of technical analysis, they
are merely one tool for establishing, analyzing, and confirming a trend.
Trend lines should not be the final arbiter, but should serve merely as a warning
that a change in trend may be imminent. By using trend line breaks for warnings,
investors and traders can pay closer attention to other confirming signals for a
potential change in trend.

29. BSE Parabolic Stock Trading
System
This particular technique has been around a long time and is still
widely used by many stock trading analysts because of its
adaptability to most markets.
History
The parabolic time/price system was first introduced by J. Welles
Wilder Jr. in his book 'New Concepts In Technical Trading
Systems'. It is very often referred to as the SAR system meaning
stop and reverse. This means when a stop is hit the system
reverses so it is permanently in the market.
The actual point at which the system is reversed is calculated on a daily
basis (or whatever time period you are looking at) and the stop moved to
create a new reverse point. The SAR point never backs up.
In other words if you are long the market the SAR point will increase
every day.
The same is true for short positions. This is the time part of the
system.
The other important part of the system is the speed at which the
SAR point moves. If the market is moving fast the SAR point will
move slowly at first and then increase as the market moves
higher, this is the price part of the system.
The rate at which the system increases is called the acceleration
factor.
It is beyond this lesson to give the exact calculation of the
acceleration factor and it is not really necessary to know the
formula as most charting services now incorporate the system in
their indicator range.
Example of what SAR looks like:

30. So far so good. The system is simple to trade and is very visual
so it's easy to know when you should be short or long. If the SAR
point (dots) is above the market you should be short and if they
are below the market you should be long.
Here's the problem! It doesn't perform very well in the markets I
have tested it on nor do I know any traders who trade it as a
stand-alone system. Maybe in the markets of the past it would
have worked well but not so now. The problem is there is just too
much whipsaw.
Now you may be asking if there is too much whipsaw why
mention the system at all? Good question and here are two
reasons I find a good use for the system.

31. Money Flow Index (MFI)and the BSE
You are going to love this lesson. MFI is based on Money Flow but the
two are not the same. Money flow analysis is a volume weighted relative
strength index. It is effective for most markets selection because it gives
a view of a stock market's essential strength or weakness. Normally,
MFI shows the same trends as the price pattern; indicating that, in an
uptrend, money is flowing into the market, and when prices fall, money is
flowing out of the market.
First Some History
The Money Flow Index was developed by Laszlo Birinyi, Jr. as a real-time
variation on the On-Balance Volume indicator.
Instead of using each day as a reference point (as OBV does), MFI analyzes
each trade.
And instead of ignoring the price or the amount that the market is up or
down, MFI weights each trade by price.
Calculation
The Money Flow Index requires a series of calculations. First, the
period's Typical Price is calculated.
Next, Money Flow (not the Money Flow Index) is calculated by
multiplying the period's Typical Price by the volume.
If today's Typical Price is greater than yesterday's Typical Price, it is
considered Positive Money Flow. If today's price is less, it is considered
Negative Money Flow.
Positive Money Flow is the sum of the Positive Money over the specified
number of periods. Negative Money Flow is the sum of the Negative
Money over the specified number of periods.
The Money Ratio is then calculated by dividing the Positive Money Flow

32. by the Negative Money Flow.
Finally, the Money Flow Index is calculated using the Money Ratio.
How to use the MFI indicator
Positive and negative divergences between price and the MFI can be used as
buy and sell signals respectively, for they often indicate the imminent reversal of
a trend.
If price is falling, but positive money flow tends to be greater than negative
money flow, then there is more volume associated with daily price rises than
with the price drops.
This suggests a weak downtrend that threatens to reverse as money
flowing into the security is "stronger" than money flowing out of it.
Chart example:
The MFI line can now be compared with the price of any security on the
BSE or other stock exchange like the New York Stock Exchange to look
for divergence.
Below is a day trading chart. This chart shows how the MFI line can be
used as confirmation of a trend change. The line on the price chart
(Point A to Point B) shows price moving down with Point B lower than
Point A while the corresponding line on the MFI (Point C to Point D)
shows the indicator moving up with Point D higher than Point C.

33. MFI Uptrend (Going long)
One way to trade the MFI is to trade divergence between price and the
MFI line. Below is a day trading chart with the MFI indicator set at 14
and the Bollinger Band indicator set at 20.

34. Trading rules for going long (buy):
• The MFI line (Point C to D) is rising while price is declining (Point
A to B).
• Enter on the first touch of price at the middle Bollinger Band line
(Point E).
• Your stop will be the first candle that closes below the lower
Bollinger Band line.
• Your target will be the first candle that closes above the upper
Bollinger Band line (Point F).
Summary
The Money Flow Index (MFI) indicator shows positive and negative
divergences between itself and price and can be used as a buy signal as
it often indicates the imminent reversal of a trend. If price is falling, but
positive money flow tends to be greater than negative money flow, then
there is more volume associated with daily price rises than with the price
drops. This suggests a weak downtrend that threatens to reverse as
money flowing into the security is "stronger" than money flowing out of it.

35. India Stock Market Cycle
In this lesson we are going to look at the different stages of a
trend and how it can help you position yourself for a trade in
any Stock market.
It is commonly accepted that there are four stages of a trend.
These stages make up a cycle and each cycle has smaller cycles
contained within them.
It doesn't matter whether you like to trade with 5-minute charts or
monthly charts. Each market will be in some stage of the cycle as
you are observing it.
Before you even think about getting into a trade you should have
some idea of where the market is in the cycle. This will help you
avoid making the wrong entry. For example, if you have identified
stage two of the cycle it doesn't make sense for you to be short
in an up stage.
If you look at the chart below you can see the 4 different stages
clearly marked:

36. Stage One
The start of the market cycle (stage one) is where there is very
little happening and the market is generally flat. At this stage the
market is normally oscillating in a certain range.
As this stage ends you often see a breakout of the previous
range. The breakout can often be explosive particularly if it has
been in consolidation for a long period of time.
For markets that can measure volume an increase of volume is
an early indication that the breakout is real.
Stage Two
Stage two is after the breakout has occurred and we begin to
head North. Depending on the force of the move the market may
rally and not come back to the breakout point or it may come
back and test that area.
In the chart example the market broke out of the range and then
rallied to R1 where it began to retreat to S1. These two points
are very important. If S1 were lower than the breakout point or

37. S1 were to rally slight but still remain below R1 then break back
down past S1 then the start of the cycle would be in doubt.
What actually happened was that the market came down to S1 and then
rallied past R1.
The aggressive trader would already have taken a position on the
breakout and most likely add to the position as R1 was taken.
If you had not entered the market yet then this would be an ideal
opportunity to jump in.
The second point to note is that the moving average began to
turn up after the breakout giving further support to the beginning
of the cycle.
In the case of the chart example I have selected a simple 40
period moving average of the closes. You can use any moving
average that suits the time frame you are dealing in.
Stage two continues making higher peaks and higher valleys and
may come back to test the moving average a few times.
Stage Three
Stage three is the final thrust of the cycle. You may notice a
spike or a double top formation as the trend begins to run out of
steam.
In our example the top is fairly flat. R2 is formed and the market
retreats to S2. What happens next is the opposite of the start of
the cycle. The market stops at S2 and then rallies slightly. The
fact that the rally did not exceed R2 is what is significant. Instead
the market only reached R3.
As soon as the market broke through S2 it signified the end of
the trend. You would also note that the moving average turned
down at this point further give support to the end of the up move.
If the top was not easily identifiable and positions closed at that
time then once S2 was taken any long positions would have
been closed.

38. Stage Four
This is the final stage of the cycle and perhaps the most
interesting. Depending on market conditions some traders may
now go short. A potential shorting point would have been on the
break of S2. The market in our example is making lower valleys
and lower peaks. This tells us that there is now a move to the
downside.
Before initiating a short on the break of S2 you could measure
the start of the whole move at the beginning of the cycle to where
the market topped at stage three. You could then calculate the
61.8% retracement (see lesson on Fibonacci). This would give
you a downside target to aim for and if there was enough meat
left in the trade initiate a short trade.
Stage four can be difficult as the market may either go into
consolidation again or continue down.
So how can this help your trading? Well, the first thing to do
before you enter a trade is decide where in the cycle you are. If
you are at stage two then it could be dangerous to go short. It
could also be dangerous to enter short if stage two had been
building for a long time. Remember the market can't go up for
ever.
On the other hand if we were entering stage four you wouldn't
want to be long. Just by identifying the different stages of the
market it can help you lock in profits, make better judgments
decisions on whether you should be in the market at all and
perhaps give you clues for entry and exits.

39. Trading BSE Stocks with MACD
The MACD is a trend-following momentum indicator that shows the relationship
between two moving averages of price. The MACD is calculated by subtracting
the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day
EMA of the MACD, called the "signal line", is then plotted on top of the MACD,
functioning as a trigger for buy and sell signals.
First Some History
Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one
of the simplest and most reliable indicators available. MACD uses moving averages,
which are lagging indicators, to include some trend-following characteristics. These
lagging indicators are turned into a momentum oscillator by subtracting the longer
moving average from the shorter moving average. The resulting plot forms a line that
oscillates above and below zero, without any upper or lower limits.
Benefits of the MACD
One of the primary benefits of MACD is that it incorporates aspects of both
momentum and trend in one indicator. As a trend-following indicator, it will not be
wrong for very long.
The use of moving averages ensures that the indicator will eventually follow the
movements of the underlying security. By using exponential moving averages, as
opposed to simple moving averages, some of the lag has been taken out.
MACD Setup
The default settings for the MACD which we will use are:
Slow moving average - 26 days
Fast moving average - 12 days
Signal line - 9 day moving average of the difference between fast and slow.
All moving averages are exponential.
Although there are three moving averages mentioned you will only see two lines.
The simplest method of use is when the two lines cross. If the faster signal line
crosses above the MACD line (The MACD line is calculated by the difference
between the 26-day exponential moving average and the 12-day exponential
moving average) then a buy signal is generated and vice versa.
It is also used as an overbought and oversold indicator. The higher above the
zero both lines are the more overbought it becomes and the lower below the zero
line both lines are the more oversold it becomes.

40. It may also lead to a stronger signal if the signal line crosses down when it is overbought
and crosses up when it is oversold. The last common use of MACD is that of divergence.
If the MACD is making new lows and the price of the security is not making new lows that
is one form of divergence (bullish divergence). Also, if the MACD has made a high and
starts to head down but price continues up that is another type of divergence (bearish
divergence) and may lead to an indication of a change in direction. (but more on this later
in the course)...
There are many ways to trade the MACD but one of our favourites are too use
two different time frames. All you do is establish a trend in a higher time period
than the one you intend to trade. For our higher time frame we like to use the 30
min chart and then drop down to the 5 min chart when conditions have been met
on the 30 min chart..
As you can see from the 30 min chart example of the BSE Sensex below there
was a bullish market signal on 12th December 06. The chart below (red arrow)
shows the MACD (red line)crossing over above the 9-day EMA (blue line)
signalling the market is going long.
The histogram represents the difference between MACD and its 9-day EMA. The
histogram is positive when MACD is above its 9-day EMA and negative when
MACD is below its 9-day EMA.

41. After confirming the signal on the 30 min chart we then dropped to the lower time
frame 5 min chart of the BSE Sensex and bought the rallies where the red
arrows show, confident to stay long (to buy) as long as our higher time period
MACD trend in the 30 min stayed intact. If the 30 min MACD signal line were to
cross down we would have closed all long positions. The chart below (red arrow)
shows the MACD (red line)crossing over above the 9-day EMA (blue line)
signalling to go long(buy) the market or in other words the market is bullish.

42. Conclusion
The MACD is not particularly good for identifying overbought and oversold levels
even though it is possible to identify levels that historically represent overbought
and oversold levels. The MACD does not have any upper or lower limits to bind
its movement and can continue to overextend beyond historical extremes.
Also the MACD calculates the absolute difference between two moving averages
and not the percentage difference. The MACD is calculated by subtracting one
moving average from the other. As a security increases in price, the difference
(both positive and negative) between the two moving averages is destined to
grow. This makes its difficult to compare MACD levels over a long period of time,
especially for stocks that have grown exponentially.
Having said that the MACD still is and will always be one of the few indicators
that all traders love and use daily and in many ways it is like seeing an old
familiar friend you know you can rely on.