Someone ask me about TA yesterday. This article caught my eye.
This is interesting, imo.
Nick's Technical Techniques
By Nick Proffitt
USING MACD
While there is no Holy Grail of technical indicators, every analyst has a
favorite, and I'm no different. For me it's the Moving Average
Convergence/Divergence Indicator, or MACD. I like it best in its histogram
form, but more on that in a moment.
There are a couple of things I like about MACD. It's a price-based indicator.
And it combines the trend-following characteristics of moving averages with
the overbought/oversold scale of an oscillator.
When they speak of MACD, most analysts are referring to the most well known
and widely used "line" form of the indicator, which uses three exponential
moving averages (EMA's) to produce two chart lines. The first line is the MACD
Line, the result of subtracting a 26 period EMA from a 12 period EMA. This
MACD Line is smoothed by a second line, called the Signal Line, which is
nothing more than a 9 period EMA. (You can set your own periods, of course,
but 26-12-9 are standard, and are what I use). The MACD Line is the faster of
the two and is usually green in color on the chart (the slower Signal Line is
red). These two lines fluctuate above and below a Zero Line.
Used as a trend following tool, MACD is a simple crossover indicator with very
simple buy/sell signals. You buy when the faster green MACD Line crosses above
the slower red Signal Line, and you sell when the MACD Line crosses below the
Signal Line. Even used in this, its most primitive form, the indicator can
provide the basis of a perfectly adequate trading system that will keep you in
sych with the trend.
If you want to get a little fancier, you can also watch for divergences
between the MACD action and price action. For example, if the price is still
rising but the MACD Line rolls over and starts downward, crossing or
threatening to cross the Signal Line, you know it's time to sell or to at
least tighten your stops. You can also use a combination of daily and weekly
MACD readings to fine tune your buying and selling; taking the direction of
your trade from the MACD indicator on your weekly chart, but picking your
exact entry point from the MACD reading on the daily chart. (If it's a buy
entry you're looking for, you'd want the weekly indicator to be bullishly
rising but the daily indicator to dropping, so you get an advantageous entry
price).
Finally, you can use MACD's Zero Line as an overbought/oversold oscillator to
calibrate your buying and selling even more finely. For example, a buy signal
crossover that occurs below the Zero Line would be confirmed when both the
MACD Line and Signal Line cross into bullish territory above the Zero Line.
Now we come to the MACD Histogram, which is the form of the indicator I
prefer, and the one I use exclusively.
The MACD Histogram plots the DIFFERENCE between the MACD Line and the Signal
Line and presents the information in the form of vertical bars (a histogram)
which fluctuate above or below a Zero Line.
In some ways the histogram is just another way to look at line MACD, because
the histogram's current bar will cross above or below the Zero Line at the
exact same time the regular indicator's MACD Line crosses above or below the
Signal Line. And just as with regular line MACD, the histogram issues
concurrent buy and sell signals. As traditionally used, when the histogram's
vertical bars cross above the Zero Line, it's a buy signal. When the bars
cross below the Zero Line it's a sell signal.
But because the histogram tracks the DIFFERENCE between the two MACD lines,
you get a bonus. You can see at a glance when the relationship between the two
lines begins to strengthen or weaken. For example, the histogram's bars may be
in bullish territory, well above the Zero Line, but if the the current bar
drops below the immediately preceding bar, you know that while still in a
bullish configuration, the spread between the MACD Line and Signal Line is
narrowing. It's a sign that price momentum may be running out of gas.
As I noted above, the traditional use of the MACD Histogram is to buy when the
bars cross above the Zero Line and to sell when they cross below the Zero
Line. This is NOT the way I use it. I have found that on the BUY side at
least, waiting for a Zero Line crossover is much too slow and usually misses
the initial, often meatiest part of a price advance.
So how do I use MACD Histogram? First, I want the indicator's bars to be well
into negative, oversold territory. In other words, well below the Zero Line;
and the farther below, the better. Next, I look for the FIRST uptick on the
weekly chart. By an uptick, I mean that the current bar suddenly stops
dropping and and instead pops higher than the immediate preceeding bar. It's
still in negative territory below the Zero Line, of course, but now it's
moving up. IF this move is corroborated by other, faster indicators on the
weekly chart, and IF the MACD Histogram bars on the daily chart are also
climbing or just bottoming, the result is one of the best, and safest, buy
signals I know of.
Using the MACD Histogram for selling purposes is a little tricker. You can, if
you choose, simply invert the buy setup. In this case, you would have watched
happily as the histogram bars marched steadily upwards, crossing the Zero
Line, and going far into overbought territory. Then, when you see the first
downtick (the current bar drops below the preceding bar), you sell. But in my
experience, simply inverting the buy criteria often leads to whipsaws or
selling too soon. I've employed various selling strategies over the years. For
a long time, I thought it best to wait for the histogram bar to drop all the
way back and penetrate the Zero Line before selling. More recently, I've
leaned toward splitting the difference, looking for a top in the histogram,
then selling after I get two or three consecutive downticks. It helps to
watch the histogram's action on the daily chart in these cases. It may also be
a good idea to rely more on other indicators for selling, rather than just the
MACD histogram alone.
Now we're ready to apply this lesson to the chart above. On the left you will
see the chart of Ciena (CIEN) as it stood on 12/23/98, when I decided to add
it to the Nick's Picks Portfolio. On the right, you'll see CIEN's chart on
1/27/99, the day the Picks Port sold the stock.
First let's look at the chart picture itself. We can see that the stock has
been in a down trend of late, and the 10 day moving average (DMA) has crossed
below the 30 DMA. But there are positive things to see as well. Price is at
the bottom of the ST regression channel (the three parallel black lines). And
look over to the left, to the late Oct. 98 period. See the lateral support
point there, marked by a small black circle? That support point is a coulple
of months old, but it was a spot from which CIEN launched an explosive three-
week rally, and it's not very far below the stock's current price.
Now let's drop down to the MACD Histogram (the blue bars). The histogram bars
have dropped below the Zero Line, and after five long weeks of level readings,
the current bar has just ticked up. Notice that during the entire time the
bars remained flat, CIEN's price continued to drop? This was a divergence, a
signal to get ready for a reversal. Also, a glance at the weekly chart (not
provided here) shows that the histogram bars just that week crossed above the
Zero Line and into bullish territory (if the weekly histogram had been TOO far
above the Zero Line, overbought, I'd have passed on the trade.)
Next we check to see if the other indicators are corroborating the MACD buy
signal. Let's look at them from top to bottom.
Stochastics, with a Slow K reading of 20, is showing that CIEN is oversold (20
or lower is oversold, 80 or higher is overbought). Moreover, the green %K line
has just crossed above the red %D line, a stochastics buy signal in its own
right.
Next, the Relative Strength Indicator (RSI) has halted its descent and has
turned up from below 40. An upturn is bullish. An upturn from below 40 is very
bullish.
Next, the Directional Movement Indicator (DMI) is showing the green +DI just
now crossing above the red -DI. That is a DMI buy signal in its own right.
Finally, Granville's On Balance Volume (OBV), which along with RSI is my
fastest indicator, has also stopped falling and has turned up, indicating that
buying volume has overtaken selling volume.
Conclusion: CIEN is a buy.
Now let's go to the chart on the right. It's a little more than a month later
and the chart is beginning to deteriorate. While the MACD Histogram is still
in positive territory (above the Zero Line), we've had three consecutive drops
in the histogram bars, telling us the spread between the two MACD lines is
narrowing, that the positive relationship is weakening. A look at our other
indictors confirms the picture. Stochastics has rolled over and is heading
south, as %K crosses below %D for a sell signal. RSI is falling fast. The DMI
lines have turned, with -DI heading toward a negative crossover with +DI. And
OBV shows a reversal, with selling volume now stronger than buying volume.
Conclusion: Time to bail.
Trade Result: A profit of +33.48% in 35 days. |
