Understanding and Using MACD continued
First, some general observations. Note that the 50-day simple moving average tracks the overall price action more closely than does the 200-day average, as we would expect. Also note that the MACD lines move between upper and lower extremes, or oscillate. This behavior puts MACD into a group of technical analysis indicators called oscillators. Also note that in most cases MACD doesn't remain at the extremes for very long; this makes MACD a good predictor of trend or direction change; when MACD is at the top end of its range, there will most likely be a change in direction; one can expect the same when MACD is at the bottom of its range.
Now let's look at some of the buy and sell signals that MACD generates. Notice the two vertical lines on the upper price chart labeled "S1" and "S2". "S1", on October 15, 2007, marks where the MACD fast line first crosses below the slow line. On that day, the SPX closed at 1548.71. Such occurrences as "S1" are not outright "sell" signals because they occur quite frequently and therefore are not the most reliable. They serve better as pre-signals or warnings that the prevailing up trend may be coming to an end. "S2", on November 5, marks where the MACD line crosses from above zero to below zero. The white horizontal line in the lower MACD chart marks the zero line. This is an outright MACD sell signal that likely indicates that the previous up trend is over and the next significant move should be to the downside. On that date, the SPX closed at 1502.17. We see that the SPX continued lower into January 2008.
It was on January 30, 2008, that the MACD fast line crossed above the slow line, generating the "B1" signal (analogous to the "S1" signal that we just discussed above). As for "S1", this is not an outright buy signal, but a pre-signal that may be warning that the present downtrend may be completing. On this date, SPX closed at 1355.81. SPX rallied from this low until making a similar low in late March. On April 2, 2008, the MACD fast line crossed through zero, generating the outright "B2" buy signal and confirming that the previous downtrend had completed; the SPX closed at 1367.53.
If you would have "sold" the SPX when the "S2" signal occurred on November 5, 2007, and then closed that position when the "B2" signal occurred on April 2, 2008, you would have captured a 134.64 point, or an 8.96%, move. You could have closed the position on the earlier "B1" signal (on January 30), for a 148.86 point, or 9.74% move. However, since the "B1" signal is not the most reliable, you would have had the risk that the SPX could have continued even lower before generating the ultimate "B2" zero-crossing.