MOVING AVERAGE CONVERGENCE-
MACD Signal line
1 2 3 4 5 6
13-day 26-day
exponential exponential 13-day EMA
Trading moving moving minus 26-day 10-day EMA
day Price average* average* EMA of column 5
0.15 0.075 0.2
0 175 175 175
1 176 175.2 175.1 0.1 0
2 178 175.6 175.3 0.3 0.1
3 180 176.2 175.6 0.6 0.2
4 179 176.7 175.9 0.8 0.3
5 179 177 176.1 0.9 0.4
6 185 178.2 176.8 1.4 0.6
7 186 179.4 177.5 1.9 0.9
* See text
Figure 4.11 Calculating MACD
If you’re less technically minded, refer back to Chapter 2 in which long- and short-run moving averages were used to generate crossovers and trading signals (remember the golden cross?). This is simply a souped-up version of the same thing.
Neither of the moving averages is plotted on the chart. What is plotted is the MACD line, which is simply the difference between these two: that’s what happens in column 5 in the table. Finally, the MACD line is itself subjected to an exponential moving average adjustment (column 6), in just the same way as George Lane arrived at ‘Slow %D’ for stochastic. The smoothing adjustment used for this is normally 0.2, for a 10-day moving average. This line is known as the signal line(sometimes Slow %D is given the same title). Its function is to be crossed by MACD: when this happens, there’s your indicator.
For some reason, the MACD formula receives far less tweaking by its practitioners than those of other secondary indicators. This happens, of course, but there’s a remarkable measure of agreement that the exponential moving averages are calculated over 26 and 13 days, and that the signal line comes from a 10-day EMA.
MACD’s ability to cope with persistent trends is very evident in Figure 4.12. It’s worth noting that RSI would have encountered similar problems to stochastic had it met up with that (unusual) bull run in the share price.
THERE ARE MANY MORE . . .
By no means has this been a complete guide to secondary signals. It does, however, cover most of the indicators in regular use in the UK, and also gives you a flavour of how secondary signals are constructed. Is that the right word? Perhaps one should say shaken as the process strikes me as similar to playing with a kaleidoscope. The contents are always the same:
it’s how you shake them and where you put the mirrors that makes for variety. And just as with a kaleidoscope, after a while you realise you could go on forever, but you’re not going to see much that you haven’t seen already.
US chartists, sometimes enthused by having studied physics to PhD level, turn out an engulfing stream of indicators. I suggest you track down Maximum Entropy Spectral Analysis (MESA), the True Strength Index, SD–TSI (Slope Divergence TSI Filter), and ‘Up Move and Then a Pullback – Adam’s Entry Technique’. Amongst others. Happy reading.
For a comprehensive (but still incomplete) discussion of secondary indicators which does not require monstrous mathematical expertise, try Schwager on Futures: Technical Analysis. Although set in the world of futures and options markets, its coverage would not be lost on a keen stock market chartist.
160 170 180 190 200 210 220
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85
-7.5 -5.0 -2.5 0.0 2.5 5.0 7.5 10.0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85
0 20 40 60 80 100
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 share price
Signal line (dotted)
MACD line
Fast %D (solid line)
Slow %D (dotted line)
under 3 0 over 70 sell
buy
sell
buy sell
day
Here, MACD gives some timely signals, and so does stochastic, at first (up to Day 48).
Later, however, stochastic is unable to cope with the confirmed trend established by the share price: note the early ‘sell’ signal (Day 58) and how, subsequently, stochastic is simply unable to deal with the steady climb.
Stochastic
Figure 4.12 MACD copes with persistent trends
The first step in MACD is to create 13- and 26-day moving averages (in fact, these are
‘exponential’ moving averages – see text) of the share price. These two series are not themselves graphed. However, the difference between them is: this is the MACD line on the lower graph. MACD is then itself averaged, to generate a second line (the ‘signal line’).
Subject to confirmation from other indicators, MACD indicates a ‘sell’ when it crosses down through the signal line, and a buy when it moves back up through it.
T he technique from Japan
A n introduction to candlestick charting
5
Steve Nison reveals all Candlestick construction Candlepower
Candlesticks tested
prices in a more elegant and readable way than the western method of adding ticks to either side of a bar. They can be thought of as squint-free (or perhaps low-squint) versions of their western counterparts.
Although devised in the late nineteenth century, candlestick charting was virtually unknown outside Japan until Steve Nison, an employee of Daiwa Securities in New York, wrote Japanese Candlestick Charting Techniquesin 1991. As charting books go, this has been a best-seller and a sequel duly arrived in 1994: Beyond Candlesticks. For stock market followers, the second book is preferable as it includes all the basics, but focuses on shares whereas the first concentrates on the futures markets.
Along with the elegance of candlesticks comes a raft of theory and an attractive new terminology. Who could resist discovering the meaning of a ‘bearish engulfing formation’, or a ‘morning star’? A cult subject took off.
Suppliers of charting software rushed to include a candlestick option in their packages.
Candlestick charting techniques echo the general Japanese fascination with the diminutive by emphasising the significance of very short-term movements in share prices. Western techniques are also alive to these, as for instance with the key reversaland spikediscussed in Chapter 3. But the candlestick tool kit includes many more variations on this theme.
Candlestick techniques also place more emphasis on reversal signals and less on continuation ones than western methods.