## MACD and Stochastic: A Double-Cross Strategy

Ask any technical trader and they will tell you the right indicator is needed to effectively determine a change of course in a stock’s price patterns. However, anything one “right” indicator can do to help a trader, two compatible indicators can do better.

This article aims to encourage traders to look for and identify a simultaneous bullish MACD crossover along with a bullish stochastic crossover and use these indicators as the entry point to trade.

### Key Takeaways

- A technical trader or researcher looking for more information can benefit more from pairing the stochastic oscillator and MACD, two complementary indicators, than by just looking at one.
- Separately, the two indicators function on different technical premises and work alone; compared to the stochastic, which ignores market jolts, the MACD is a more reliable option as a sole trading indicator.
- However, the stochastic and MACD are an ideal pairing and can provide for an enhanced and more effective trading experience.

## Pairing the Stochastic and MACD

Looking for two popular indicators that work well together resulted in this pairing of the stochastic oscillator and the moving average convergence divergence (MACD). This team works because the stochastic is comparing a stock’s closing price to its price range over a certain period of time, while the MACD is the formation of two moving averages diverging from and converging with each other. This dynamic combination is highly effective if used to its fullest potential.

## Working the Stochastic

The history of the stochastic oscillator is filled with inconsistencies. Most financial resources identify George C. Lane, a technical analyst who studied stochastics after joining Investment Educators in 1954, as the creator of the stochastic oscillator. Lane, however, made conflicting statements about the invention of the stochastic oscillator. It’s possible the then-head of Investment Educators, Ralph Dystant, or even an unknown relative from someone within the organization, created it.

A group of analysts most likely invented the oscillator between Lane’s arrival at Investment Educators in 1954 and 1957, when Lane claimed the copyright for it.

There are two components to the stochastic oscillator: the %K and the %D. The %K is the main line indicating the number of time periods, and the %D is the moving average of the %K.

Understanding how the stochastic is formed is one thing, but knowing how it will react in different situations is more important. For instance:

- Common triggers occur when the %K line drops below 20—the stock is considered oversold, and it is a buying signal.
- If the %K peaks just below 100 and heads downward, the stock should be sold before that value drops below 80.
- Generally, if the %K value rises above the %D, then a buy signal is indicated by this crossover, provided the values are under 80. If they are above this value, the security is considered overbought.

#### MACD And Stochastic: A Double-Cross Strategy

## Working the MACD

As a versatile trading tool that can reveal price momentum, the MACD is also useful in the identification of price trends and direction. The MACD indicator has enough strength to stand alone, but its predictive function is not absolute. Used with another indicator, the MACD can really ramp up the trader’s advantage.

If a trader needs to determine trend strength and direction of a stock, overlaying its moving average lines onto the MACD histogram is very useful. The MACD can also be viewed as a histogram alone.

## MACD Calculation

To bring in this oscillating indicator that fluctuates above and below zero, a simple MACD calculation is required. By subtracting the 26-day exponential moving average (EMA) of a security’s price from a 12-day moving average of its price, an oscillating indicator value comes into play. Once a trigger line (the nine-day EMA) is added, the comparison of the two creates a trading picture. If the MACD value is higher than the nine-day EMA, it is considered a bullish moving average crossover.

It’s helpful to note there are a few well-known ways to use the MACD:

- Foremost is the watching for divergences or a crossover of the center line of the histogram; the MACD illustrates buy opportunities above zero and sell opportunities below.
- Another is noting the moving average line crossovers and their relationship to the center line.

## Integrating Bullish Crossovers

To be able to establish how to integrate a bullish MACD crossover and a bullish stochastic crossover into a trend-confirmation strategy, the word “bullish” needs to be explained. In the simplest of terms, bullish refers to a strong signal for continuously rising prices. A bullish signal is what happens when a faster-moving average crosses up over a slower moving average, creating market momentum and suggesting further price increases.

- In the case of a bullish MACD, this will occur when the histogram value is above the equilibrium line, and also when the MACD line is of greater value than the nine-day EMA, also called the “MACD signal line.”
- The stochastic’s bullish divergence occurs when %K value passes the %D, confirming a likely price turnaround.

## Crossovers in Action: Genesee & Wyoming Inc.

Below is an example of how and when to use a stochastic and MACD double-cross.

Note the green lines showing when these two indicators moved in sync and the near-perfect cross shown at the right-hand side of the chart.

You may notice a couple of instances when the MACD and the stochastics are close to crossing simultaneously: January 2008, mid-March and mid-April, for example. It even looks like they did cross at the same time on a chart of this size, but when you take a closer look, you’ll find they did not actually cross within two days of each other, which was the criterion for setting up this scan. You may want to change the criteria so you include crosses that occur within a wider time frame so you can capture moves like the ones shown below.

Changing the settings parameters can help produce a prolonged trendline, which helps a trader avoid a whipsaw. This is accomplished by using higher values in the interval/time-period settings. This is commonly referred to as “smoothing things out.” Active traders, of course, use much shorter timeframes in their indicator settings and would reference a five-day chart instead of one with months or years of price history.

## The Strategy

First, look for the bullish crossovers to occur within two days of each other. When applying the stochastic and MACD double-cross strategy, ideally, the crossover occurs below the 50-line on the stochastic to catch a longer price move. And preferably, you want the histogram value to already be or move higher than zero within two days of placing your trade.

Also note the MACD must cross slightly after the stochastic, as the alternative could create a false indication of the price trend or place you in a sideways trend.

Finally, it is safer to trade stocks trading above their 200-day moving averages, but it is not an absolute necessity.

## Special Considerations

The advantage of this strategy is it gives traders an opportunity to hold out for a better entry point on up-trending stock or to be surer any downtrend is truly reversing itself when bottom-fishing for long-term holds. This strategy can be turned into a scan where charting software permits.

With every advantage of any strategy presents, there is always a disadvantage. Because the stock generally takes a longer time to line up in the best buying position, the actual trading of the stock occurs less frequently, so you may need a larger basket of stocks to watch.

The stochastic and MACD double-cross allows the trader to change the intervals, finding optimal and consistent entry points. This way it can be adjusted for the needs of both active traders and investors. Experiment with both indicator intervals and you will see how the crossovers will line up differently, then choose the number of days that work best for your trading style. You may also want to add a relative strength index (RSI) indicator into the mix, just for fun.

## Ways to use MACD

Good Day Traders,

In this article I will tell you some ways to use the MacD oscillator. It’s for sure one of the most popular indicators in the trading community and created by Gerald Appel in the late 1970s. You can see Macd in several forms out there because the traders and the coders try to adjust it to the their current strategy.

The default setting of this indicator are (12,26,9). Look at the first screen shot.

It’s from EURUSD currency pair. In this chart we have a MacD with default settings without the histogram. We have only the zero line(the purple line) and two EMAs, the 12 day which is the faster one and the 26 day which is the slower. Now, form this screen shot we could take some signals. When the EMAs are above the zero line there is a bullish activity. On the other hand, when the EMAs are below the zero line there is a bearish activity. In the chart you can see some put arrows. There arrows are EMAs crossovers. When the slower 26 EMA(the blue one) is above the 12 fast EMA we have short signal. In the opposite condition when the faster EMA is above the slower we have a long signal. The problem with this indicator is that it creates so many signals and as it’s natural many of them are wrong. Take a look in the second screen shot.

This is the same chart with the above EURUSD but here you can see a different view of MACD. We have a histogram. In the histogram notice the colors. We have light green and dark green. Red and dark red. When the histogram makes bars below the zero line it’s a bearish signal and when makes bars above the zero line it’s a bullish signal. Notice some spots in which there are bars above the zero line but we have down moves. These are with dark green color. It means that we have a down move but the momentum is still bullish and there is still bullish activity.

The best signals is when the MACD makes bars clearly above or below the zero line. You can use both the histogram and the EMAs to have a better picture what going on. Another way to use this indicator is the divergence as I said before in my article about divergences.

## What Is the MACD Indicator and Why Is It So Special?

**Moving average convergence/divergence or the MACD** is one of the simplest and most effective momentum oscillators ever created. The MACD is a trend-following momentum indicator. The indicator was developed by Gerald Appel in the late 1970s.

## How does MACD work?

This indicator is well suited to identify entry and exit points. The MACD provides corresponding signals in the beginning and in the end of the trend.

### Fast and slow lines

It may seem like understanding the principles behind the MACD is harder than putting the indicator into practice. To better illustrate the logic of the moving average convergence/divergence we can resort to the exponential moving averages (EMA) with periods of 12 and 26.

The MACD is an instrument based on the EMA lines

The following observations can be made by looking at the picture above:

- The intersection of two moving average lines on the price chart corresponds to the intersection of the fast MACD line (blue) and the horizontal zero line. The value of the MACD is equal to the difference between exponential moving averages with corresponding periods.
- The slow (orange) line in the MACD indicator window is the average of the MACD line (blue).

### Green and red bars

The one can also note that alongside with blue and orange lines the MACD uses green and red bars.

The green and the red bars indicate the distance between the slow and the fast MACD lines

Green bars will appear in the MACD window when:

- the fast line is above the slow line and the distance between the two lines is increasing;
- the fast line is below the slow line and the distance between the two lines is decreasing.

Red bars will appear in the MACD window when:

- the fast line is below the slow line and the distance between the two lines is increasing;
- the fast line is above the slow line and the distance between the two lines is decreasing.

It may seem a little bit complicated but the general idea behind the bars is simple. When the blue line moves up faster or moves down slower than the orange line, the MACD will display green bars. In the opposite case, the bars will become red.

## MACD Settings for Day Trading

In order to use the MACD indicator in day trading, click on the “Indicators” button in the bottom left corner of the screen. Then choose the MACD from the list of possible indicators.

Setting up the indicator. Step one

Click “Apply” if you want to use the indicator with standard parameters. Or you can adjust fast, slow and signal periods in the open tab.

Setting up the indicator. Step two

The sensitivity of the indicator can be increased by decreasing the fast period and increasing the slow one.

## How to Use Indicator in Day Trading?

Thanks to the complex nature of the indicator there are several ways to put the MACD into action.

**Signal line crossovers**. An uptrend is expected when the fast line turns up and crosses above the slow line. A downtrend is expected when the fast line turns up and crosses below the slow line.

Signal line crossover as an indicator of the bullish trend

**Centerline crossovers**. An uptrend is expected when the fast line moves above the zero line to turn positive. A downtrend is expected when the fast line moves below the zero line to turn negative.

Centreline crossover as an indicator of the bullish trend

**Divergences**. Divergences appear when the price chart and the MACD chart show oppositely directed movement. A bullish divergence forms when a security records a lower low and the MACD forms a higher low. A bearish divergence forms when a security records a higher high and the MACD Line forms a lower high. Divergence can be a sign of an upcoming trend reversal.

Divergence as an indicator of the upcoming trend reversal

The MACD gives traders an opportunity to simultaneously use a trend-following and a momentum indicator. It can be applied to both short and long time intervals, making it an ultimate tool in the hands of a professional.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.

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