Would you believe that the sharemarket has different moods?
Sometimes it feels good and that means the market is moving up. Sometimes it feels terrible and down in the dumps and then guess what happens? The market tends to fall.
For traders and investors, when you take notice of the market mood, you can gauge the feeling that is likely to dominate the market before it impacts too heavily on share prices.
There's an easy way to gauge the feeling of the market – it's called the Moving Average Convergence Divergence (or the MACD for short). Or you could call it the 'happiness gauge'.
The MACD is used to determine when the mood of the market changes and helps you identify a change in trend.
The MACD uses two lines:
The two lines represent the moving average of the difference in the moving averages. Don't worry if that’s difficult to get your head around. You never actually have to calculate, draw or plot these lines. They are given to you when you use a charting tool and nominate the MACD indicator.
When you see a crossover of two lines, it potentially means a change in sentiment.
Note: the chart above is of the ASX 200 in January and February 2010. If you would like a bigger copy please email me at moneymakers@belldirect.com.au.
When the sharemarket's mood is turning from good to bad, it's usually time to sell. You can see this in the chart above. When the red line moves below the blue line in the bottom half of the MACD graph, this is usually a sell signal (I've placed a big frown on the graph to plot where that has happened). It represents that the faster moving average has started to move lower and has crossed the slower line. The mood of the market is changing to a negative mood, so beware!
Conversely, when the red line moves above the blue line in the bottom half of the MACD graph, then the market mood is turning from sad to happy (this time I've placed a big smile at this point). It represents the fast line moving higher and it has crossed the slower line, usually indicating a buy signal.
You can see that we saw a negative mood changing signal around 14 January which would have been a potential signal to sell. You can also see that a positive mood change signal happened around 15 February which would have been a potential signal to buy.
While this is a useful tool to have, there is one main drawback. The MACD is a lagging indicator, which means that it gives a signal to sell after the market has already started to move. It tends to lag price action.
On the flip side, MACD tends to be more accurate compared with a leading indicator.
Unfortunately the market doesn't consist of just good or bad moods. Sometimes it's difficult to get a sense of what mood the market is in. So if you're seeing confusing signs, ignore that indicator and find another tool in your trading box to try and analyse the market.
Happy (or sad!) trading.
Julia Lee Equities Analyst Bell Direct Have you started trading with Bell Direct for just $15 a trade? Register now for free.