Stay On Track Zero In On The MACD Do you find that you trade more than you'd like to while a market is trending? Here’s a variation on the moving average convergenceldivergence you can use to keep you in trending markets longer so you can capture more of a trend. espite the advances in technical analysis, the moving average convergence/divergence (MACD) indicator created by Gerald Appel almost 40 years ago remains a mainstay in the trader's toolbox. Its popularity is well-deserved since it serves ‘more than one purpose. It functions as a momentum oscillator,a directional indicator,an indication of price vigor and, for some, a standalone trading system. The MACD consists of two parts: the MACD line and the signal line, The standard MACD settings found in most charting software subtract the ference between the 12-period exponential moving average (EMA) and 26-period EMA to create the MACDine. Itconstructs the signal line by overlaying a nine-period EMA of the value of the MACD line. ‘The MACDlinecrossing MACD are whether it is above or below zero, and whether itis rising or falling. Inthis article, Il eliminate the signal line and focus only on the MACD line and its relationship to its zero line, which will highlightthe trending and momentum features of the MACD. Focusing on the MACD zero line crossings rather than on the signal line crossings often reduces the number of trades taken and keeps traders in a trend longer. THE DISPLAY Usually, the MACD is presented as a solid line that fluctuates above and below a zero line, as seen in Figure 1. But for this article, I'l present it in a histo- gram-line style format, which produces vertical lines above and below zero, making it easier to see when it actually crosses its zero line. To eliminate the signal line, change the nine-period default to a one-period EMA. Also important is that the MACD values be expressed as a percentage of movement rather than as the change in actual dollar amount. the signal line generates buy and sell signals. The chart of Scana Corpora- tion (SCG) in Figure 1 illustrates the MACD line and its signal line. The arrows show where the buy and sell signals occur. Itis the use of the MACDssignal crossovers that many traders find most appealing. htt F = However, according to E Appel, two of the most # important features of the FIGURE 1: SCAMA ($C) WITH THE MAGD INDICATOR. Oriariy he MACD ncalordepays an WACD re (hb) ands ‘signal ne (ned. The css ofthe MACD Ine onthe signal ine generates by and sel sgnals. The aos an he price bars and ‘he ted and green Ines inthe MACD instr paral pon ou both the oct and the requncy ote euyisel signals on SC tom Oetober 20146 Je 2% = by Barbara Star, PhD Copyright © Technical Analysis Ine. www.Traders.comsmmodities V. 34:05 (8-12, 47): Zero In On The MACD by Barbara Star, PRD Figure 2 displays SCG in the format being used in this article. The chart contains a 12-period EMA, and a 26-period EMA on price, with the MACD in the lower panel. The up and down arrows identify the moving average crossovers, which match the places where the MACD crosses its zero line, I have used blue bars to show when the MACD is above the zero line and red bars when it is below the zero line. If these changes are not possible to make in the software you are using, then simply select price oscillator indicator, sometimes also called a price ercentoscillator,.hich s availablein most charting software, Set the fast EMA to 12 and the slow EMA, to 26, Display it using a histogram line style instead of the default solid line style ‘Many programs also include a feature commonly referred to as the MACD histogram. ‘That feature subtracts the numeric value of the signal line from the MACD line to display, in histogram form, the difference or space between the two lines. If possible, ‘urn off that function because itis not the same as the histogram line style that I use in this article, INTERPRETATION By itself, the MACD provides traders with a good indication of whether the trading environment favors be rll qr FIGURE 2: SCANA WITH THE MACD LINE DISPLAYED AS A HISTOGRAM. Elminatng he signal In aa playing he MACD ln in ahiogramlin style above anabelow is er ne alowsaders To%eeus on prea ens and ake fone vases, ro Yall a bial iy, la wor map | FIGURE 8: THE 3M COMPANY (MIM) AND THE MACD AS A HISTOGRAM. "he incaor and fae bat are colered tue when fe MACD ie above ile zr ne an red when tne WACO fe baow is zr ne. This highghis shits n both wend and momentum. The char denies divergences and 708 consléaions beween pice movement and the indicator moverent, bulls or bears. An MACD above zero is generally a positive signandwhen below ts zerline, itis generally negative, Buteven better,the MACD allows traders tocatch major trends, both bullish and bearish, that occur in any time frame. For example, in Figure 3, the trend of 3M Company (MMM) favored the bulls during the four months From November 2014 through February 2015 while the blue vertical lines remained above zero. Price then transitioned into a bearish six-month period with the red vertical lines below zero as 3M gave back all fits gains. Note the colors of the price bars correspond to those ofthe MACD histogram. For the eSignal code for colored bars, see the online sidebar ‘eSignal Code For MACD Colored Bars” at hitp:/traders.comfilesStarl60S html Figure 3 als illustrates the value of the MACD as a momen- tum indicator. When itis above its zero line and rsin that momentum or the price rate of change is rising. When itis above its zero line but has stopped rising and instead has begun decreasing, moving toward the zer0 line, it indicates lessening ‘of momentum even if price continues to rise, Often, decreasing ‘momentum leads to a corrective pullback and sometimes to a complete change of trend. ‘When the histogram hovers or fluctuates nearits zero line, as it did in March and April, it signifies weak momentum, which reflects priceaction during sideways jindecisive,or range-bound price action. In this case, movement was confined within a six-point price range during that time period before breaking support to the downside in late April ‘An MACD below zero and falling indicates that momentum has hiftedtothe downside andprice action goncrally isnegative. ‘When the MACD stops declining and begins to rise toward its itmeans Copyright © Technical Analysis Ine. zero line, the negative momentum is not as strong, This often ‘occurs duringacountertrendrally ater which price may continue its downtrend, but it may also lead to a change in trend, Divergence reversals. Sometimes itis possible to identify an ‘upcoming reversal by watching for bullish or bearish diver gences, These occur when price moves in one direction but the MACD does not reflect that move. For instanee, in Figure 3, price made a high in December and the MACD also made a high, Aftera pullback, price rallied to a new high atthe end of | February but the MACD made a lower high. Soon after, price corrected and moved into a sideways channel that provided ‘temporary support prior to its major decline, Alter falling below its zero Tine, price and the MACD. ‘made a series of lower lows until late August. A brief, shallow rally was followed by a retest of the lows in September, which Drought price close to the August lows, However, the MACD ‘made a higher low that formed a bullish divergence and led to ‘a change in trend Divergences do not always occur,and when they do they may not [ead to a trend reversal, but they do point to a change in momentum that could result in, or from, a change in investor behavior, which makes divergences worth observing, ‘TRADING THE ZERO LINE CROSSOVER ‘While the MACD zero line crossoversindicatea potential change in direction, they don't necessarily mean itis time to enter the market, For the timing of entries and exits I find it helpful to www.Traders.comStocks & Commodities V. 34:05 (8-12, 47): Zero In On The MACD by Barbara Star, PhD apply a 34-period weighted moving average (WMA) anda 55-period FMA to the price bars. As illustrated. inthe chart of First SolarIne, (FSLR) in Figure 4,enter the long side when price is above the red $8 EMA and when the price bars are blue. For short selling, center (o the downside when price moves below the '58-period EMA and the price bars are red. ‘When prices penetrate the 34-period WMA, itean signal acountertrend rally anda need to protect profit by moving a stop-loss. When the momentum of the MACD begins to show signs of a weakening trend as it did in January, price enters the space between the two moving averages. In February, the space began tapering, becoming narrower as the 34 WMA began moving up in response to rising prices. Price crossed the 55 EMA and the bars turned blue when. the MACD crossed above its zero line, signaling a change inmomentum anda potential change of trend. In this case, it was a countertrend rally that lasted from February through April before FSLR resumed, its downtrend, WARNINGS AND ALERTS Since not all price movements lead to trends and since no trend lasts foreveritishelpfultohaveawarning method tien those times when price retraces, becomes choppy, ot consolidates Figure 5 shows FSLR with a warning method T use that f ays diamond symbols above and below price, For eSignal code to display the diamond symbols see the online sidcbar “eSignal Code For Warning Symbols" at htpiitraders com! filesStar 1605. hom ‘A diamondsymbol above the price bar warns when the price close is less than the 34-period WMA and the price highs greater than or equal tothe 35 EMA. ‘That occurs when price enters the space between the two moving averages Diamond symbols apear below the price tars when the 55 EMA is above the 4 period WMA and the price closes above the 34-period WMA. This alert occurs during a price decline to warn the trader of a possible shi price to the upside. ‘The code for the warning symbol that appears below the price bars is more conservative in that it requires the shorter 344-period WMA to have been below the $5 EMA and then eross EMA before it signals an all-clear. The code was written that way to help avoid some of the pullbacks and false breakouts that often occur soon after price begins to move from a downtrend to an uptrend. However, as seen in the February time period in Figure 5, playing it safe may cause traders to delay entry toolong, missing additional profi. Aggressive trad- crs may wish to take their chances, using a prudent stop-loss, EMA and the above the and enter as soon as price is above the red 5 Copyright © Technical Analysis Ine. allt aaa “qe FIGURE 4 FIRST SOLAR FSLR) WITH MOVING AVERAGES. cg he aod wei es S:potod exponen moving averages provides erty and canary pits fr ads etait a ral ll, rare omy FIGURE 5: FRET SOLAR WITH WARING SYMBOLS. Tre danond warning syrbac above and ‘below the price bars alert aders o some ting pitas created by rebacemenis, consolidator, and choppy price maven. si, al amvncat il titiot,, i FIGURE 6: WEEKLY MARKET VECTOR SEMICONDUCTOR TF (SMH) WITH WARNING SYMBOLS. ‘The waning symbols could hae heled ders voi whipsaw pie acon por tothe star ot along lth ond and also alerts thom the 207 ané 2018 market cece price bars turn blue. hese warning symbolsalsoalert tradersto those times when price isin a sideways consolidation period and momentum has decreased, keeping the MACD near its zero line. An example of that type of price behavior appears in the lower left-hand side of the weekly Market Vectors Semiconductor ETF (SMH) cchart in Figure 6 prior to its two-and-a-half-year bullish run, These alerts can help traders avoid the whipsaws so common in the use of moving averages and indicators, such as the MACD, that are based on moving averages. However, once the trend began, traders of SMH were warned of the impending price decline in October 2014, which oc- ccurred while the MACD was above its zero line and price bars remained blue. More recently, traders had ample opportunity to www.Traders.comsmmodities V. 34:05 (8-12, 47): Zero In On The MACD by Barbara Star, PRD take profits beginning in late June through mid-July. 2015 when the warning symbols appeared above the price bars prior to price breaking the $5 EMA, the MACD falling below its zero line, and the price bars turning red, ANOTHER ALERT STRATEGY: AROON | found that the aroon indicator developed by Tushar Chande offers another useful method for alerting and/or confirming changes in the MACD. Unlike the FIGURET: inate Ines ae another method hat warn o conn the MRCD changes nrc direction, 8 ctessoers of he atoon MACD, whichis. price-based momentum indicator, the aroon indicator incorporates a ime dimension ty identifying now highs and lows made over a user- defined ime period. Chande used a25-bar period, but he wrote that anytime period couldbeused, However, the 25 period seems io sync well withthe MACD, so Tred iin the charts for this article Theindicator available inmost software packages, is comprised of twolines:anaroon-upand naroon- down These line fluctuate ona seale of zero to 100 with zero indicating weakness and 100 indicating | / sirength. The aroon indicator is designed to reveal [= ‘we re ie Sul Peel re Ph! the beginning of a new trend or change in price bias. According to Chande, the trend is shown by the line that most recently reached the 100 level. In keeping with the colors used to identify the direction of the MACD, I colored the aroon-up Line blue and the aroon-down line red in my example charts. Ian aroon-up line hits 100, it isa sign thata potential change in price direction from down or sideway' to up may soon oveur. Ifprice continues to advance, then the aroon-up will remain at ‘oF near 100, indicating a strengthening trend, ‘When the aroon-down Line surges to the 100 level and the aroon-up declines to zero, it warns of a potential change of trend to the downside, If price continues to make new lows, then the aroon-down remains at or near 100 as the trend be- comes stronger. When it takes longer to continue making new price highs or lows within the chosen time period (as often occurs during retracements,cange-boundactivity,orsideways price movement), ‘an aroon line weakens and begins to decline from the 100 level, At some point the aroon-up and aroon-down lines will eross as cone or the other sharply rises to warn of a directional change. Crossover examples. It is the crossover and the immediate move up to 100 that will serve as an alert or to confirm the directional changes seen with the MACD line. In Figure 7, the aaroon-up crossover that occurredin June 2015 onthe daily chart of the medical technology company Becton Dickinson & Co. (BDX) confirmed the MACD change from red to blue on the price bars, The cross of the aroon-down in August alerted of 2 possible price change to the downside, which did take place a few days later as the MACD fell below its zero line and the price bars broke below the moving averages. The October aroon-up crossover occurred just as price pushed above the moving averages to begin another rally Copyright © Technical Analysis Ine. FIGURE 8: ARCHER DANIELS MIDLAND (ADM) WITH AROOW ALERTS, Tho roan ncatorsone times issus false aes, ast cdin August. tis best o wat for a clear tend change rom tbe WACO. and te moving averages before entering a ade Focusing on the MACD zero line crossings rather than on the signal line crossings often reduces the number of trades taken and keeps traders in a trend longer. The chart of Archer Daniels Midland (ADM) in Figure 8 illustrates that some aroon indicator crossovers produce false signals, especially those that occur after price has been trading sideways. The crossovers in April and June 2015 proved to be good alerts that occurred two to five days before the MACD ‘erossedits zero line and price moved above or below its moving. averages. However, he aroon-up rossoverin August produced afalse alert, which took place following a month of sideways, price inactivity during July, while the MACD was below its zero line, The MACD never erossed above the zero line and price did not rally above its moving averages. Instead, price ‘continued its decline and soon the aroon-down reasserted its dominance with a signal that confirmed the downtrend, The lesson here is to let price and the MACD reflect the trend ‘change before pulling the entry trigger. STAYING IN A TREND Taking a longer-term perspective that emphasizes price trend www.Traders.comStocks & Commodities V. 34:05 (8-12, 47): Zero In On The MACD by Barbara Star, PhD reduces some of the noise, and stress, that often accompany the se of shorterterm trading strategies. Displaying the MACD ‘without its signal line and focusing on the ebb and flow of the indicatorahove and below its zero linc offers raders one method ‘or taking that longer-term view. Adding moving averages and indicator alerts can offer valuable trading filters. Barbara Star, PhD, isa retired university professor. She is a ast vice president of the Market Analysts of Southern Cati- “fornia and led a MetaStock users group for many years. She +has had articles and software reviews published in echnical Analysis of STOCKS & COMMODITIES since 1991. Currently, she trades part-time and provides individual instruction and consultation to those interested in technical analysis of ‘the financial markets, She lives in Woodland Hills, CA and ‘can be reached at 818 224-4070 or by email at star4070@ aol.com. The online sidebars containing the eSignal code mentioned inthis, articlecanbefoundathttp:itraders.comifles(Starl605.himlaswell 4s inthe Article Code area at our website, Traders.com: Copyright © Technical Analysis Ine. ‘Seeour Traders’ Tipssection beginning onpage SOfor commentary ‘onimplementation of Barbara Star'stechniquein various echnical analysis programs. Accompanying program code can be found in the Traders’ Tips area at Traders.com FURTHER READING Chande, Tushar S. [1995]. “A Time Price Oscillator” Tech- nical Analysis of STOCKS & COMMODITIES, Volume 13: September. + www:signalert.com/MACD tutorial pa + www systemsandforecasts.com /maed. html eSignal www.Traders.com