Overview

In Part Two we learned about Stock Scanner, a tool which allows simplifying the stock picking process. We will dedicate this article to the subject of technical analysis, charting and chart indicators. Same as before, you can use your existing account at vivatrader.com to try out all the things we will be talking about.

What is technical analysis?

Simply put, technical analysis involves studying of past price changes in hopes to forecast future price direction. Why is it important? Well, the reason is simple. If you are buying a security and hope to profit from selling it down the road, you have to know where the price is going. I have to mention right away, that technical analysis cannot predict the exact price movement, but it can help you make an informed decision.

How does it work?

There have been many techniques developed since the inception of stock markets. Hundreds of various methods of technical analysis exist today. One of the most popular, though, remains charting and studying of various technical indicators. This method is ideal for a beginner trader, since it does not require sophisticated hardware or software, and many sites exist that offer this kind of service for free or for a reasonable price.

As before, we will be using vivatrader.com, which offers a comprehensive set of technical indicators.

Which technical indicators should we use?

There is a broad number of indicators available. Some of them, which are also available at vivatrader.com, are listed below:

• Average Directional Index
• Ichimoku Clouds
• Parabolic SAR
• TRIX
• Average True Range
• Keltner Channels
• Price Channels
• Bollinger Bands
• MA Envelopes
• Rate of Change
• Ultimate Oscillator
• Aroon
• Choppiness Index
• Moving Averages
• Relative Strength Index
• Williams%R
• Aroon Oscillator
• Commodity Channel Index
• MACD
• Fast and Slow Stochastic
• Average Directional
• Index  Force Index
• Money Flow Index
• Stochastic RSI (StochRsi)

For the purposes of this article we will be using MACD, or Moving Average Convergence Divergence.

MACD Overview

Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of prices. The default MACD is represented as the difference between a 26-day and 12-day EMA of the price. A 9-day EMA of the MACD, referred to as the signal (or trigger) line, is plotted on top of the MACD to indicate buy/sell opportunities. Divergence, the difference between the MACD and the signal, is also plotted as a histogram. The MACD is most effective in wide-swinging trading markets.

That sounds too complicated! But it is not, really, once you start using it.

Using MACD on IBM ticker

Let's bring up the chart for IBM, to do that click the preceding link or simply enter IBM into the Stock Ticker box in the upper right corner on the VivaTrader.com site. This page, called Ticker Research, has a lot of information available about the ticker. Here's a brief description:

• Info
• Quote
• Charts
• Intraday Charts
• News
• Options
• Prices

Click on the Charts tab; this will bring up a chart, which shows price movements in the candlestick format. We will talk more about this format in next chapters, for now I'll just mention that this format in itself is used by many traders to analyze prices. We want to add the MACD indicator to this chart.

To do so, click the button Indicators and choose MACD under the Indicators menu item (there are overlays and indicators). Do not enter anything in the parameters box for now, just click OK.

The chart will change, now it consists of two parts. The price chart remains in its place, and below it we can see another chart, which consists of 3 graphs. What would that mean though?

MACD explained

As with any technical indicator, MACD is used to get hints, not price predictions. There are three standard ways to interpret the MACD:

• 1. Crossovers: The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy signal occurs when the MACD rises above its signal line. It is also popular to buy/sell when the MACD goes above/below zero.
• 2. Overbought/Oversold Conditions: The MACD is also useful as an overbought/oversold indicator. When the shorter moving average pulls away dramatically from the longer moving average (i.e. the MACD rises), it is likely that the security price is overextending and will soon return to more realistic levels. MACD overbought and oversold conditions exist vary from security to security.
• 3. Divergences: An indication that an end to the current trend may be near occurs when the MACD diverges from the security. A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. A bullish divergence occurs when the MACD is making new highs while prices fail to reach new highs. Both of these divergences are most significant when they occur at relatively overbought/oversold levels

Visual alerts

Deciphering MACD might not always be easy, especially for beginner trader. VivaTrader.com has a very nice helpful tool, which is called Visual alerts. It can spot various signals that any given indicator has produced, and it will plot those signals right on the same chart. I highly recommend this feature, it will save you a great deal of time, especially if you use it in conjunction with the Stock Scanner tool, which we learned about in Part  Two.

It is very simular in use to the Indicators button. Click the Alerts button, which sits next to the Indicators button, and it will bring up another popup window, where you can choose any signal you want. You will notice that the MACD indicator produces the following 4 alerts:

• Bullish MACD crossover: A MACD cross above the signal line (9-period EMA) is often used by traders to suggest an increase in upward momentum. This signal can occur many times for any particular security, so be careful to avoid false signals. It is a wise decision to use other technical indicators to confirm the upward momentum predicted by a bullish MACD crossover.
• Bearish MACD crossover: A MACD cross below the signal line (9-period EMA) is often used by traders to suggest increased downward momentum. This signal can occur many times for any particular security, so be careful to avoid false signals. It is a wise decision to use other technical indicators to confirm the downward momentum predicted by a bearish MACD crossover.
• MACD cross above zero: A MACD cross above zero signals to the trader that the short-term moving average (12-day EMA) is crossing above the long-term moving average (26-day EMA). This moving average crossover suggests that the security is likely to experience an increase in upward momentum.
• MACD cross below zero: A MACD cross below zero signals to the trader that the short-term moving average (12-day EMA) is crossing below the long-term moving average (26-day EMA). This moving average crossover suggests that the security is likely to experience an increase in downward momentum.

So choose any signal you want to see on your IBM chart and click OK. You will see the relevant signals popping up as little red flags on the price chart.

Conclusion

In this chapter we learned how to employ technical analysis in day trading and what tools could be used to make this process easier. We looked at the MACD indicators and the various tools you could use at VivaTrader.com for technical analysis.