Subtracting the slow line (signal line) from the fast line (MACD line) creates the MACD histogram. Plot the difference in the form of histogram bars. When the fast line is above the slow line, the histogram bar is plotted above the zero line. When the fast line is beneath the slow line, the bar is beneath the zero line. The slope of the histogram depends on the difference between the fast line and the slow line. Stronger bull action will cause the fast line to be farther above the slow line; thus the histogram will have longer lines above zero. The same holds true to the downside when the bears take control.
The right way to use the MACD histogram is:
1. Trade in the direction of the slope of the histogram. If the slope is positive, trade from the long side; if it is negative, trade from the short side.
2. Sell longs or trade from the short side when the histogram is above the zero line and the slope heads downward. This indicates that the bulls have lost steam and a reversal is in the making.
3. Cover shorts or trade from the long side when the histogram is below zero and the slope turns upward. This indicates that the bears are out of gas and the bulls are taking back the reins.
4. Go long with bullish divergence between lower prices and a higher histogram.
5. Go short with bearish divergence between higher prices and a lower histogram.
Figure 17-2 shows a chart of Dell Computer (DELL) with MACD lines superimposed on top of the chart, and with an MACD histogram displayed beneath the chart. The chart also has an 8-period moving average. Toward the end of July and the beginning of August, DELL formed bullish divergence with the MACD histogram. On the second higher bottom of the MACD histogram, DELL also formed a hammer followed by a bullish engulfing pattern. During this period, the fast line on the MACD crossed above the slow line.
To view this image, please refer to the print version of this book
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