Ask Colin

With MACD, what is the zero line and how is it calculated? I understand that, as a general rule, buy signals given below the zero line are supposed to be much stronger than those given above - the latter signals being in stocks that could be considered to be overbought. I also wondered whether you had formed any views yourself, in relation to the Australian stockmarket, on whether focusing much on the location of the zero line is worthwhile. I notice that a number of stocks that have been performing well in recent months (such as ABC, DOW and ION) are above the weekly MACD zero line. I also notice that, if one never bought stocks that were above the zero line, one would have missed out on a nice upwards move in CSL. (On the other hand, I see that, by waiting patiently, one can find a similarly well-regarded long-term performer, CBA, falling down below the weekly zero line.)

In essence the MACD is a momentum oscillator calculated by taking the difference between two moving averages. So, it is a specific form of the moving average oscillator. The signal line is simply a moving average of the MACD line.

The zero line is simply where the two moving averages that make up the MACD line cross. You could trade the crossovers of the zero line - that would be the simple two-moving average method. However, it does not give good signals - they tend to be too late.

Far better is to trade the crossovers of the MACD and signal lines, which gives an earlier signal.

When a stock has been sold off significantly, the first signal will often be below the zero line. I have heard it said that the best signals are deep in negative territory. However, if a stock is in a good uptrend and you want to get into it, you may never get such a signal.

My thought is that the zero line is not that significant. However, the one thing that I would avoid is buying a crossover that was a long way above the zero line. Because the MACD oscillator has no fixed limits, it is not possible to set overbought levels except with reference to previous swings. However, the further above the zero line you are, the closer you will be to an overbought level.

MACD should never be used on its own. There must be a price signal that you are acting on. This price move will be confirming the MACD or vice versa. Thus a long decline that turns up might be confirmed by a MACD signal below zero. A breakout above a consolidation zone might be confirmed by a MACD signal near the zero line. These are nice, but frankly, they are the bleeding obvious. I find the price is all you need to trade good signals. If you need the MACD to find a trade that is not obvious by looking at the price, you are probably looking at a weak trade.

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