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
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.
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
