Combining our indicators for confirmation
Two of my favorite trading indicators are Moving Average Crossovers and
MACD. When these two indicators in sync, trading signals tend to be more
reliable.
Today, October 20, 1999, the general market seemed to have broken up from a
congestion area. A negative after the close in IBM’s report may
dampen market sentiment, so wait for a continuation of today’s move
before taking this trade or any trade.
Moving Averages and Moving Average Crossovers
The moving average crossover method calculates two moving averages, each
based on a different number of periods of trading data. When the
shorter-term (fewer period) average crosses above the longer-term average
from below, this is a buy signal. When the shorter-term average crosses
below the longer-term average from above, this is a sell signal.
Moving averages are used to smooth prices, dampening the distractions of
short price movement so that the underlying trend is clearer. Moving
averages always lag the market and, therefore, will never buy market
bottoms or sell market tops. Like any other trend-following system, the
moving average crossover will perform best when markets are trending
because it automatically places the trader on the right side of every
extended move. When markets are moving sideways, however, the lack of
extended moves will cause losses.
Moving Average Convergence/Divergence (MACD)
The MACD is a trend following momentum indicator that shows the
relationship between three moving averages of prices.
This method can be used for any time frame. It could be 5 minute bars, 15
minutes bars or daily bars. Many traders will also trade in multiple time
frames using a longer time frame for trend, and the shorter period for
entry and exit.
The MACD is the difference between a 26-period and 12-period exponential
moving average. A 9 period exponential moving average, called the "signal"
(or "trigger") line is plotted on top of the MACD to show buy/sell
opportunities. On the charts below, the MACD line is the green colored
line, and the trailing, slower moving line is the signal line. Some
technical analysis programs will show the MACD as a histogram bar.
There are three popular ways to use the MACD: crossovers,
overbought/oversold conditions, and divergences.
The most common use is as a crossover method. Using this interpretation,
the trading rule is to sell when the MACD falls below its signal line.
Similarly, a buy signal occurs when the MACD rises above its signal line.
It is also popular to buy/sell when the MACD goes above/below zero.
Some traders will use MACD as an overbought and oversold indicator. When
using the indicator in this manner, when the shorter moving average pulls
away dramatically from the longer moving average (i.e., the MACD rises), it
is likely that the security price is overextending and will soon return to
more realistic levels. MACD overbought and oversold conditions vary from
security to security.
The other way some traders use MACD is to spot divergences from an
anticipated movement. Since there are no indicators or patterns that work
all the time, reactions against the anticipated move can signal a major
move. A bearish divergence occurs when the MACD is making new lows while
prices fail to reach new lows. A bullish divergence occurs when the MACD is
making new highs while prices fail to reach new highs. Both of these
divergences are most significant when they occur at relatively
overbought/oversold levels.
Let's look at Applied Materials (NASDAQ: AMAT)
For the past week, AMAT dropped from 83 to 73.
The moving average indicator would have given a nice exit and/or short signal.
The MACD had already indicated a Sell before the Moving Averages.
Today, October 20, 1999, both the MACD and Moving Averages gave new Buy
signals.
An ideal entry would have been 1:00 PM EST.
If AMAT opens up and takes out today's high of 78 �, I would Buy the
stock.
If an entry is made on the break, I would place a stop at 76.
Remember that the idea is to enter in momentum, wait for confirmation.
Sometimes earnings of a major stock or economic release can change
overnight opinions.
