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“There is no cure for birth and death, save to enjoy the interval,” said the Spanish-American poet George Santayana. If the MACD had existed at the time (1922), he would have surely included it in the list of the things that give pleasure. Indeed, the MACD (Moving Average Convergence Divergence) is one of the most remarkable tools of technical analysis, because it is able to illustrate, in a highly reliable way, a price trend’s moments of weakness and strength.
The way it works is relatively simple. It is based on three moving averages: the long-term price trend (LTMA); the short-term price trend (STMA); and the difference between the two previous averages (MACD).
Graphically speaking, the LTMA is a horizontal line. The STMA moves around this line and the MACD average follows, lagging somewhat behind the STMA, as shown in Figure 1. In this diagram, the letter T stands for time; PD is the positive difference between the STMA and the LTMA; and ND is their negative difference.
Figure 1 – MACD diagram .
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An increasing difference between the STMA and the LTMA indicates that the price trend is strong; a decreasing difference that the trend is weakening.
| The graph of the MACD shows a point at which the decrease in the difference between the STMA and the LTMA (that is, the weakening of the trend) announces the end of the current trend and the beginning of the new trend in the opposite direction. In the MACD diagram, these points are S1 and S2 (signaling a downtrend) and B1 and B2 (indicating the uptrend). These points occur where the STMA and the MACD average cross. |
The MACD is available in all technical analysis programs and its classic features are those shown in Figure 2: the LTMA covers 26 periods; the STMA 12 periods; and the MACD average 9 periods. (In the example, the period is a stock exchange trading session.) The sinuous blue region around horizontal line 00 (the LTMA) shows the variation in the difference between the STMA and the MACD average. However, its utility is mostly decorative in this example. The resulting graph gives, on average, one signal per month if the security or fund has a relatively low volatility, as is the case for XEG (Figure 2), an ETF (exchange-traded fund) of energy stocks traded on the Toronto Stock Exchange. Investors who have the time can track several securities at the same time or use a MACD in which each period is, for example, 15 minutes.
Figure 2 shows the graph of XEG at the end of June. Options on XEG are available at the Montreal Exchange.
Figure 2 - The bar chart of the XEG and the graph of its MACD. This type of graph is available on the DDweb platform
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Investors who buy at point B1, when the security is at $50, and sell at S1 ($60) make a $10 profit on a $50 investment in two months, equivalent to an annual return of 120%.
Another excellent profit opportunity comes between the purchase signal at B3 ($57) and the sale signal at S3 ($67): a $10 profit a $57 investment in 40 days, or an annual return of 160%. On the other hand, the B2 signal to buy at $57.50 followed by S2 signal to sell at $56.00 is damaging, which proves that not only good signals but also bad signals exist. However, the profit from the good ones largely exceeds the loss from the bad ones. Investors can check the value of this instrument by using it in their securities portfolios.
Technical analysis is performed using around 100 tools, the majority of which are redundant. One small number is the basis for all the others, and it is the most reliable. The MACD is one of this select group of tools and investors should adopt it. As Jean Nidetch, cofounder of Weight Watchers International, has said, “ It’s choice – not chance – that determines your destiny. ”
| N.B.
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nature, suitability or potential value of an investment or of
any trading strategy. |
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