The MACD (shown below) can be used in both trends and ranges if used properly. This is one of the few tools that will work well in both types of markets. If I could only have one technical indicator outside of trend
lines/support/resistance, this would be it.
There are several ways to use the MACD indicator. In up trends, you’ll only take buy signals as the price is also somewhat near the uptrend line. All of this will be illustrated in a visual below. However, let’s go into how to read the signals more.
When the MACD lines go downward, then cross and turn upward, you have a MACD buy signal. You can get a head jump on the MACD lines crossing many times by using the Histogram bars. When the lines are heading down and the lines look like they are attempting a cross but haven’t yet, you can look to the histogram bars for a head jump on the actual signal. When the MACD is wanting to turn upward and the red histogram bars start to get less negative (meaning they are growing shorter), then you can try to buy ahead of the signal (crossing).
When the MACD lines are trying to turn down, you can look to the black lines to start growing shorter to get a quicker entry on the MACD signal lines. This will help you sell in a more timely fashion.
lines/support/resistance, this would be it.
There are several ways to use the MACD indicator. In up trends, you’ll only take buy signals as the price is also somewhat near the uptrend line. All of this will be illustrated in a visual below. However, let’s go into how to read the signals more.
When the MACD lines go downward, then cross and turn upward, you have a MACD buy signal. You can get a head jump on the MACD lines crossing many times by using the Histogram bars. When the lines are heading down and the lines look like they are attempting a cross but haven’t yet, you can look to the histogram bars for a head jump on the actual signal. When the MACD is wanting to turn upward and the red histogram bars start to get less negative (meaning they are growing shorter), then you can try to buy ahead of the signal (crossing).
When the MACD lines are trying to turn down, you can look to the black lines to start growing shorter to get a quicker entry on the MACD signal lines. This will help you sell in a more timely fashion.
Formula:
In downtrends you’ll only take sell signals (to sell short) near the downtrend line. When the MACD lines go upward, cross, then turn downward, you have a
sell or sell short signal.
In ranges, you can take both signals equally.
There are two more ways in which the MACD can be used. One is the MACD zero line and the other is divergence. The MACD zero line is where the histogram flips from black to red and back to black. When the MACD is below the zero line, it’s generally bearish. When the MACD is above the zero line, it’s generally considered bullish. See the example below. I’ve shown where the zero line is by highlighting it in yellow.
Divergence is where the price goes in one direction but the MACD goes in another direction. While this isn’t a trading signal in and of itself, it can be of great help. When the stock breaks in the direction that the divergence
suggested, and closes beyond the trend line, then you have a signal to trade off of. See the examples of divergence below. The red lines point to one set of divergences while the blue lines point to a second set of divergences. As you can see, the MACD can be very useful in many ways and in trends or ranges.
Just to recap the MACD, there are several ways it can trigger signals:
1. The lines crossover (MACD line crosses the signal line)
2. Going above/below the zero line
3. Divergence with price confirming
Moving Averages
There are a number of common moving averages. They all have their pros and cons. First, lets take a look at what moving averages are and do. Moving averages take the averaging of a stock’s price over a certain period that you define. What this does is smoothes out the data so you can tell “on average” if the stock is going upward or downward. After all, that’s the name of the game. So a moving average is good about answering the question of “what direction to trade”. (However, you’ll find that the MACD answers the questions of “when to trade”.) So when you combine the two, they can be powerful. Moving averages are mainly good in trends and do little good in ranges. So now the question is which moving average periods are best. The most commonly used moving averages are 10, 20, 50 and 200 day Simple Moving Averages. It’s important to know that there are other types of moving averages out there that aren’t quite as widely used such as Exponential Moving Averages (EMA’s) and Weighted Moving Averages (WMA’s). However, most big institutions use the simple moving average. A simple moving average weights all the data the same while an exponential or weighted moving average places more emphasis on the latest data (towards the right of the chart) rather than the older data (towards the left half of the chart).
So a simple moving average of 10 periods is going to give us the average price of that stock over the last 10 days. With each new day, it adds in that day to the data and drops off the oldest day to calculate the new average. The moving average is a smoothed line that connects all of these averaging points together into the moving average line.
A 10 or 20 period moving average is going to change quicker with the price action and hug closer to the price action. The pro is that it’s quick in responding to price movements. Its con is that while it does somewhat act as support/resistance; it’s a weaker one than a longer term moving average. A longer term moving average such as the 50 or 200 day simple moving average will respond slower to the price action (con) but offers stronger areas/regions of support/resistance in and of themselves than do the shorter moving averages (pro).
Let’s take a look at some below and see what they look like on the chart. Below we see a (20 day SMA) distinct downtrend on the left side of the chart and then it switches into an uptrend later on in the chart. In the final 2-3 months of the chart, the QQQQ’s go into a sideways range. This is where the moving averages would do little good except show that it’s in a range. Note that when the QQQQ’s are distinctly trending downward, the moving average provides an area of resistance. When the QQQQ’s are in an uptrend, the moving average acts as a general area of support for the price. When it goes into a range, it doesn’t act as either support or resistance.
Moving Averages are used to smooth the data in an array to help eliminate noise and identify trends. The Simple Moving Average is literally the simplest form of a moving average. Each output value is the average of the previous n values. In a Simple Moving Average, each value in the time period carries equal weight, and values outside of the time period are not included in the average. This makes it less responsive to recent changes in the data, which can be useful for filtering out those changes.
See also Exponential MA, Least Squares MA, Triangular MA, Weighted MA, Welles MA, Variable MA, Volume Adjusted MA, Zero Lag Exponential MA, DEMA, TEMA and T3.
So a simple moving average of 10 periods is going to give us the average price of that stock over the last 10 days. With each new day, it adds in that day to the data and drops off the oldest day to calculate the new average. The moving average is a smoothed line that connects all of these averaging points together into the moving average line.
A 10 or 20 period moving average is going to change quicker with the price action and hug closer to the price action. The pro is that it’s quick in responding to price movements. Its con is that while it does somewhat act as support/resistance; it’s a weaker one than a longer term moving average. A longer term moving average such as the 50 or 200 day simple moving average will respond slower to the price action (con) but offers stronger areas/regions of support/resistance in and of themselves than do the shorter moving averages (pro).
Let’s take a look at some below and see what they look like on the chart. Below we see a (20 day SMA) distinct downtrend on the left side of the chart and then it switches into an uptrend later on in the chart. In the final 2-3 months of the chart, the QQQQ’s go into a sideways range. This is where the moving averages would do little good except show that it’s in a range. Note that when the QQQQ’s are distinctly trending downward, the moving average provides an area of resistance. When the QQQQ’s are in an uptrend, the moving average acts as a general area of support for the price. When it goes into a range, it doesn’t act as either support or resistance.
Moving Averages are used to smooth the data in an array to help eliminate noise and identify trends. The Simple Moving Average is literally the simplest form of a moving average. Each output value is the average of the previous n values. In a Simple Moving Average, each value in the time period carries equal weight, and values outside of the time period are not included in the average. This makes it less responsive to recent changes in the data, which can be useful for filtering out those changes.
See also Exponential MA, Least Squares MA, Triangular MA, Weighted MA, Welles MA, Variable MA, Volume Adjusted MA, Zero Lag Exponential MA, DEMA, TEMA and T3.
Formula:
Now that we’ve taken a look at a shorter term moving average, let’s now look at a longer term moving average, the 200 SMA.
This average points to the long term trend direction and shows where many of the long term investors may be holding the stock. It’s averaging the last 200 days of data. Notice how it can act as regions of support in an uptrend or regions/areas of resistance in a downtrend
PSAR and ATR What indicators can be used to help determine stop levels? The Parabolic SAR (PSAR) or the Average True Range (ATR). The pros to the Parabolic SAR is that the stop levels (dots on the chart below) work good in a strong trend but don’t work good at all in ranges. Even in mild trends I’d discourage their use. However, look at how well they do on the strong trending part of the chart pointed out below. Consider placing your stop at the point of the red dot on the chart underneath the uptrend.
Parabolic SAR The Parabolic SAR calculates a trailing stop. Simply exit when the price crosses the SAR. The SAR assumes that you are always in the market, and calculates the Stop And Reverse point when you would close a long position and open a short position or vice versa.
Parabolic SAR The Parabolic SAR calculates a trailing stop. Simply exit when the price crosses the SAR. The SAR assumes that you are always in the market, and calculates the Stop And Reverse point when you would close a long position and open a short position or vice versa.
The Parabolic SAR was developed by J. Welles Wilder and is described in his 1978 book, New Concepts In Technical Trading Systems.
Formula:
Another alternative is the ATR. This one can be effectively used in a range or a trend. What you’d do is take the most recent ATR levels into consideration. In this instance, the stock has averaged around 70-80 cents a day on its daily range. So when you buy this uptrend, you could place your stop a bit over 70-80 cents away from your entry price. Long term traders/investors might even double or triple that number. This at least gives you an idea of the volatility of the stock. Every stock will have a different volatility and will therefore need a different distance between it and its entry and stop levels. Also, the larger the time frame, the wider the stop. So a daily chart would have a larger ATR reading than a 60 minute chart. Again, I’d not use both of these (ATR and PSAR) on a chart at the same time as it would just confuse. Pick only one. If the stock is ranging then there is only one smart choice, the ATR. If it’s trending then you have two choices. Pick whichever one speaks to you the best.
Average True Range (ATR) The ATR is a Welles Wilder style moving average of the True Range. The ATR is a measure of volatility. High ATR values indicate high volatility, and low values indicate low volatility, often seen when the price is flat.
The ATR is a component of the Welles Wilder Directional Movement indicators (+/-DI, DX, ADX and ADXR).
The ATR was developed by J. Welles Wilder and is described in his 1978 book New Concepts In Technical Trading Systems
Another alternative is the ATR. This one can be effectively used in a range or a trend. What you’d do is take the most recent ATR levels into consideration. In this instance, the stock has averaged around 70-80 cents a day on its daily range. So when you buy this uptrend, you could place your stop a bit over 70-80 cents away from your entry price. Long term traders/investors might even double or triple that number. This at least gives you an idea of the volatility of the stock. Every stock will have a different volatility and will therefore need a different distance between it and its entry and stop levels. Also, the larger the time frame, the wider the stop. So a daily chart would have a larger ATR reading than a 60 minute chart. Again, I’d not use both of these (ATR and PSAR) on a chart at the same time as it would just confuse. Pick only one. If the stock is ranging then there is only one smart choice, the ATR. If it’s trending then you have two choices. Pick whichever one speaks to you the best.
Average True Range (ATR) The ATR is a Welles Wilder style moving average of the True Range. The ATR is a measure of volatility. High ATR values indicate high volatility, and low values indicate low volatility, often seen when the price is flat.
The ATR is a component of the Welles Wilder Directional Movement indicators (+/-DI, DX, ADX and ADXR).
The ATR was developed by J. Welles Wilder and is described in his 1978 book New Concepts In Technical Trading Systems
Fibonacci Retracements A term used in technical analysis that refers to the likelihood that a financial asset's price will retrace a large portion of an original move and find support or resistance at the key Fibonacci levels before it continues in the original direction. These levels are created by drawing a trend line between two extreme points and then dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. Fibonacci retracement is a very popular tool used by many technical traders to help identify strategic places for transactions to be placed, target prices or stop losses.
Volume higher than average volume can confirm tops and bottoms at times. See how well
it did this on Ford stock below.
Volume can also confirm and add validity to a breakout and help confirm that it’s not a false breakout. See how it helped confirm the downside break down of Hewlett Packard stock. Trend lines/Support/Resistance/Volume are some of the best indicators you’ll ever find.
ADX (Average Directional Index) The ADX (Average Directional Index) is another indicator to help determine if a stock is ranging or trending. If you couple this with support/resistance lines (black) in a range or trend lines (red and blue), then you get an even more accurate picture of what the ADX is trying to say. When the ADX is above 30ish, the stock is considered to be trending. It could be trending up or down but this just states that it is trending. The ADX line is the green line below. When the blue +DI line is op top (and the ADX is above 30ish), it means the trend is upward. When the –DI is on top (and the ADX is above 30), you have a downtrend. This can also be even more accurately confirmed by the trend lines below. When the ADX is below the yellow 30 level (drawn on the chart for emphasis), it is considered to be in a range. At these times, you could use other ranging indicators that well be discussing such as the RSI or Bollinger Bands. You can and should always draw the somewhat horizontal support/resistance (black) lines when in a range. The ADX is a Welles Wilder style moving average of the Directional Movement Index (DX). The values range from 0 to 100, but rarely get above 60. To interpret the ADX, consider a high number to be a strong trend, and a low number, a weak trend. The ADX was developed by J. Welles Wilder and is described in his 1978 book New Concepts In Technical Trading Systems.
Formula:
Directional Movement Index (+DI and -DI)
The +DI is the percentage of the true range that is up. The -DI is the
percentage of the true range that is down. A buy signal is generated when the
+DI crosses up over the -DI. A sell signal is generated when the -DI crosses
up over the +DI. You should wait to enter a trade until the extreme point is
reached. That is, you should wait to enter a long trade until the price
reaches the high of the bar on which the +DI crossed over the -DI, and wait to
enter a short trade until the price reaches the low of the bar on which the
-DI crossed over the +DI.
The DI was developed by J. Welles Wilder and is described in his 1978 book New
Concepts In Technical Trading Systems.
Formula:
Bollinger Bands
Bollinger Bands – work well in ranges but not in trends. When in ranges, buy
when the price goes at or outside of the bottom band. Sell either at the
moving average (higher probable and more conservative) or at the opposing band
(more aggressive). In a range, sell short (which contains more risk) at the
top band and buy back to cover the short at the moving average (conservative)
or at the opposing band (more aggressive).
Bollinger Bands were developed by John Bollinger.
Formula:
RSI (Relative Strength Index)
The RSI (Relative Strength Index) gives overbought/oversold readings
accurately only in ranges. In trends, they would tend to give many false
signals. See the circled signals below. While the RSI can be used to spot
divergences, the MACD is better to use typically for that.
The Relative Strength Index (RSI) calculates a ratio of the recent upward
price movements to the absolute price movement. The RSI ranges from 0 to 100.
The RSI is interpreted as an overbought/oversold indicator when the value is
over 70/below 30. You can also look for divergence with price. If the price is
making new highs/lows, and the RSI is not, it indicates a reversal.
The Relative Strength Index (RSI) was developed by J. Welles Wilder.
Formula:
Slow Stochastic
The Slow Stochastic is also a range bound indicator. It needs a sideways
market in order to be accurate with its overbought/oversold signals. See on
the left side of the chart that it gives bad signals (shown by the “X” over
them). Yet on the latter half of the chart, the stock is in a range and gives
accurate signals. While Stochastics can pick up divergence, the MACD is still
better used for that. (Note: There is also the Fast Stochastic but whipsaws so
much that it tends to do very little good and not many ever use it.)
The Stochastic Oscillator measures where the close is in relation to the
recent trading range. The values range from zero to 100. %D values over 75
indicate an overbought condition; values under 25 indicate an oversold
condition. When the Fast %D crosses above the Slow %D, it is a buy signal;
when it crosses below, it is a sell signal. The Raw %K is generally considered
too erratic to use for crossover signals.
The Stochastic Indicator was developed by George C. Lane.
Terminology:
| Fast Stochastic | Refers to both %K and %D where %K is un-smoothed |
| Slow Stochastic | Refers to both %K and %D where %K is smoothed |
| Raw %K | Un-smoothed %K |
| Fast %K | Un-smoothed %K |
| Slow %K | Smoothed %K |
| Fast %D | Moving average of an un-smoothed %K |
| Slow %D | Moving average of a smoothed %K, in effect: a double smoothed %K |
| %D | Always refers to a smoothed %K (whether or not the %K itself is smoothed) |
Formula:
Recap
To recap: The best technical indicators are firstly trend
lines/support/resistance/volume. After that would come the versatility of the
MACD. It can be left on the chart at all times. Use only buy signals in the
uptrend and sell signals in the downtrend. Use both signals in a range.
In Trends use 2-3 of the following maximum:
1. Trend lines
2. Moving Averages
3. MACD (buys in uptrend or sells in downtrend)
4. ADX (above 30)
5. PSAR (for stops in strong trends) OR
6. ATR levels for stops
In Ranges, use 2-3 of the following maximum:
1. Support/Resistance
2. MACD – both buy and sell signals
3. Bollinger Bands
4. RSI
5. Slow Stochastics
6. ADX below 30
7. ATR levels for stops
