Momentum in the capital markets is similar to the momentum of riding a bicycle especially down a hill. The more speed a bicycle rider has, the further they are likely to go. The same goes for market momentum, so the key is figuring out how to measure it, and use that information to generate trading signals. One of the best tools to use to measure momentum is the MACD – Moving Average Convergence Divergence Index. The MACD measures the difference between two moving average, referred to as the spread, and compares the spread to a moving average of the spread.
The defaults for the MACD are the 12-day moving average and the 26-day moving average to create the spread. This difference is compared to the 9-day moving average of the spread. For binary options traders interested in intra-day periods, an hourly or 15-minute bar can be used to create signals. Traders should also considered altering the default periods to find a grouping of time periods that suits their trading style. For example, a short term trader could consider a 5-day / 9-day spread periods with a 3-day moving average of that spread.
The S&P 500 graph shows the last two crossover signals generated by the MACD. The black arrows show a buy signal that was generated in early July which caught the majority of the July rally. It also displays the sell signal created just after the S&P 500 index topped, which also proved to be profitable.
The MACD is a leading indicator, and generally catches the beginning of a trend. The risk is that during a consolidative period, the MACD generates many false signals during a choppy market environment.
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