The Stochastic and the MACD are two technical indicators that are very popular with traders seeking to interpret trends.
As all traders know, there is no perfect technical indicator. Each investor uses, based on experience, the one that suits them best according to their profile and objectives. The MACD indicator is particularly popular, and is a must when it comes to interpreting trends. However, like any indicator, it has certain shortcomings that another analysis tool, such as Stochastics, could well compensate.
Here is a complete summary of the information you need to know about the specifics of the Stochastic and MACD indicators, enabling you to make one or both part of your analysis.
Stochastics
Stochastics are a technical indicator that compares the current price of a financial asset with previous prices over a given period. It was developed in the 1950s by George Lane, an American trader, technical analyst and lecturer. This indicator is a momentum oscillator that varies between the values 0 and 100. It highlights support and resistance levels, as well as overbought and oversold areas, similarly to the RSI indicator. Consequently, the Stochastic is an excellent indicator of loss of momentum.
It is represented graphically by two curves, namely :
- the %K line, which measures the current closing level relative to the lowest level over the observed period
- the %D line, which is a simple moving average of %K
When the price of the financial asset in question rises above 80, the market enters a period of buying frenzy. Conversely, when its price falls below 20, the market goes into a selling frenzy. When the price exits one of the extreme zones of the Stochastic, the trend loses steam.
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The MACD indicator
The Moving Average Convergence Divergence (MACD) is a technical indicator for identifying and anticipating trends in the financial markets. It is calculated using moving averages. The succession of crossings and divergences of these moving averages allows traders to interpret trends and position themselves optimally.
The MACD indicator is graphically represented by two curves
- The first curve is the difference between a long-term exponential moving average (EMA) (usually 26 periods) and a short-term exponential moving average (usually 12 periods).
- The second curve is simply an exponential moving average of the fast MACD line, with a duration of 9 periods.
Buy and sell signals are given by the crossing of the two curves. Thus, when the fast MACD line crosses the upward signal line, it is a buy signal. Conversely, when the fast MACD line crosses the downward signal line, it is a sell signal.
Stochastics vs MACD
Stochastics therefore provide valuable information on the strength of trends, highlighting in particular phases of excess buying and selling, as well as the loss of momentum in strong trends. The MACD indicator, on the other hand, provides information on trend reversals, revealing clear buy and sell signals to investors. In fact, rather than opposing these two indicators and favoring only one, many traders combine them, enabling them to refine their perception of trends and thus increase their chances of generating gains.
Indeed, an indicator of the strength of price movements such as the Stochastic oscillator can complement the MACD. This is the "Double-Cross" strategy : for example, if a bullish cross is observed by the trader on both indicators in parallel, a strong bullish signal is fully confirmed - even more so if the MACD crosses the equilibrium line shortly after the Stochastic. The combination of these two technical indicators allows, after finding the right period setting, to obtain much better reversal signals and safer entry points to the markets.
Stochastic and MACD indicators are therefore good tools for technical analysis and interpreting price trends. Taken separately, the MACD seems superior to Stochastics, which gives false signals over short periods of time in an intraday strategy, where the MACD is much more accurate. However, the MACD can benefit from the parallel use of Stochastics, which provide the investor with information on the strength of the movements.
