Professional Documents
Culture Documents
Wayne A. Thorp - The MACD A Combo of Indicators For The Best of Both Worlds PDF
Wayne A. Thorp - The MACD A Combo of Indicators For The Best of Both Worlds PDF
Moving averages are Moving averages are the easiest and most popular technical indicators. But
they are trend-following indicators that work best in strong trending periods;
trend-following in fact, moving average trading systems tend to lose money during periods of
indicators that don’t choppy trading.
work well in choppy Since markets and individual securities will, at some point, enter a period of
markets. Oscillators sideways or choppy trading where prices move up and down without any
tend to be more sense of direction, you may want to turn to an indicator that is more sensitive
and responsive to that kind of trading behavior. Oscillators fit this bill.
responsive to that Technicians use oscillators in a variety of ways—to determine overbought
kind of trading and oversold conditions, to determine the momentum of a security or index,
behavior. The as well as to identify divergences between price and the indicator.
moving average This article focuses on one indicator that combines the best of both
convergence/ worlds—the trend-following characteristics of moving averages, and oscillator
characteristics that help indicate whether a security is overbought or oversold
divergence indicator and that help pinpoint potential divergences. The indicator is called moving
combines those average convergence/divergence, more commonly known as MACD.
characteristics.
CALCULATING THE MACD
INTERPRETATION
To understand how the MACD can be used in trading, you first need to
know how it works.
Wayne A. Thorp is assistant financial analyst of AAII. The figures in this article were
produced using MetaStock by Equis.
OVERBOUGHT/
OVERSOLD
the behavior of the MACD over this Figure 4 for Allegheny Energy. signals carry more weight than
period, you may be able to pick out During the period from September weekly signals.
some recurring patterns in the price 1995 through February 1996, both While weekly signals are of greater
and the MACD. The two darker the price and MACD rose steadily. importance than daily signals, that is
horizontal lines in the MACD After that point, however, a diver- not to say you should write-off the
window mark the overbought and gence developed between the price usefulness of daily movements.
oversold regions for Cascade. At the and the indicator. From February of One technique used by technicians
top region (overbought) you can see that year until January of 1997, the is to track the behavior of the
where the stock price frequently MACD made a steady decline while MACD on a daily basis. However,
experienced a fall shortly after the Allegheny’s price, for the most part, instead of entering or exiting a trade
MACD penetrated this level. At the continued to make higher highs. The based on a daily signal, they refer to
oversold level, the stock price often fall in the MACD is due to the the weekly chart to see where the
saw an increase shortly after this coming together of the 12-week and MACD is. For example, if you
region was reached. Again, it is 26-week exponential moving aver- receive a buy signal from the daily
important to point out that these ages, which can also be seen in MACD and you see that on the
levels are subjective and will vary Figure 4. Eventually, the price weekly chart the MACD is in a
from security to security. reversed course and fell back in line bullish “condition,” you may wish
with the MACD. to enter a long position. However, if
DIVERGENCES A bullish divergence takes place the weekly MACD is in an over-
when the MACD is making new bought condition, you will probably
The third popular use of the highs even though prices fail to want to ignore the buy signal from
MACD is to identify those times reach new highs. Again, greater the daily MACD.
when it diverges from the security importance should be placed if the Overall, you can use daily charts
price. A divergence occurs when the price makes a new relative low (a to determine entry and/or exit points
trend of a security’s or index’s price price trough is lower than the or to identify early trend warnings;
does not agree with that of an previous price trough) while this ideally after you refer to a weekly
indicator. In other words, an pattern develops. Furthermore, both chart.
indicator trends in one direction signals carry greater significance if
while the price goes another, or does they occur at relative overbought or TRADING COMPANION
not go in the same direction. MACD oversold levels.
divergences tend to preface a The MACD takes the principle of
reversal in the current price trend of DAILY VS. WEEKLY moving averages and advances it one
the security or index in question. step further.
A bearish divergence occurs when All of the MACD examples here This indicator is useful when
the MACD is making new relative are calculated using weekly prices. examining the interaction between
lows even though the price fails to No matter which indicator you use, two moving averages. In addition, it
make new lows. An even stronger signals generated always carry more is helpful in identifying points when
warning is sounded in this case if the weight as the time period being used the indicator and price diverge.
price makes a new relative high (the to calculate the indicator increases. However you may use it, the
price peak is higher than the last Weekly signals are more significant MACD could be a useful trading
price peak). This is the case in than daily signals, just as monthly companion. ✦