The MACD - An Anachronism?
The MACD is one of the three technical indicators most commonly used by traders, and used in many different ways. According to Chat GPT:
MACD is a versatile indicator that provides insights into trend direction, momentum, and potential entry and exit points in trading.
In other words, the MACD seems to be a one-size-fits-all, one-stop-shop for traders. But is it really as good as it seems? Let’s look at its history, but first bear with me for a moment.
The Persistence of Standards
Like many people, I thought that the width of train tracks was determined by the width of a horse’s bottom (being polite here) and I always wondered what the horses were doing on the train tracks (although, actually, they were!)
Checking it out, I discovered that it is 4 ft 8.5 ins because the first rail lines were built by the people who built the tramways (which preceded the railroads) and so they used the same tools and equipment. But why did they use that wheel spacing? Because before trams they built wagons, and all the wagons had this wheel spacing. Why?
Blame the Romans!
When Romans conquered Britain, one factor in their success was creating a network of roads which allowed them to move swiftly, and ensure supply lines and communications. Naturally, they relied on horses, and chariots which had iron tires that scarred the roads.
In the centuries that followed people still used the Roman roads, and had to make sure that their wagon wheels matched the ruts made by the chariots otherwise their wheels would break!
What does this have to do with the MACD?
The MACD is based on 3 EMAs (Exponential Moving Averages) and the standard settings for the MACD are 12, 26 and 9. An odd choice, one would think.
It is generally thought that these numbers were chosen because Appel (the inventor of the MACD) tested many parameters and these proved the most effective. Given that this was the seventies, ticker tape was still being used and computer power was limited, this seemed unlikely.
Digging a bit deeper I discovered the simple reason: in the seventies there were no trading platforms, and technical analysis was based on daily charts. The working week used to be 6 days – so the 9 corresponded to one and a half weeks, the 12 to 2 weeks, and the 26 to one month. Now, of course, the working week is 5 days.
Should the parameters be changed to 7.5 (not sure how you do that!), 10 and 21? Most ‘experts’ caution against changing the settings and the 12-26-9 is used by a majority of traders and as they base buying and selling decisions on them they tend to push the prices in that direction.
What MACD settings could we use?
After a few months away from strategizing and testing, I have jumped in again, and created some models to test various strategies. I am just finalizing the MACD one right now, so I should have more information quite shortly.
Options Trading for Beginners
I published a new book, Options Trading for Beginners, a couple of weeks ago. I didn’t mention it here because it is aimed at beginners, and if you are already trading options, you would know most of the stuff in it.
However, if you know someone – child, friend, colleague, partner – who might be interested in learning the basics about options then please recommend it. It’s a short read (1 – 2 hours) with no complicated payoff diagrams – promise! Here’s the link: Options Trading for Beginners.
SPY Chart
Monday, Tuesday & Wednesday – wonderful! I was hoping we had turned the corner, and the bull market was resuming. I was slapped down on Thursday and Friday, in no uncertain terms.
We are well away from the uptrend that was in place until late July, and may possibly be developing a downtrend (the royal blue line) Support around 430 may be holding, it all depends on this week. The gap formed on the 21 September has not get been filled, so that is not a good sign. The 10 SMA has ticked up away from the 200 SMA so it is unlikely we will have to take any action this week.
I have put the MACD on the chart since we have been talking about it, and we can see that the histogram turned positive on Monday, but now it looks as though it may be contracting. However, that is not unusual; after 5 positive days you expect a bit of a pull back as some traders take profits.
SPYG Chart
SPYG is rather more encouraging than SPY: the gap (green box) has been filled and it is now bumping up against resistance at $61. The 10 SMA is moving away from the 200 SMA, so any actions here are also unlikely this week.
I have put the MACD on, just for curiosity, and like SPY it turned positive last week.
QQQ Chart
QQQ has been in consolidation (a sideway pattern) since early June, not yet reaching its high from early July. It has twice bounced off $355 so I would say that this is now a support level that we have to watch. It is encountering resistance around the $370 level. I have put the MACD histogram on this chart also, for comparisons.
VIX Chart
The VIX has climbed quite a bit, but lets keep it in perspective. Technically, we are still in a low-volatility period.
ITMeter
Comments and Questions
There were quite a few instances of readers posting questions and not apparently getting a reply. This was because I was leaving previous blog posts open for comments, and the replies were there rather than on the latest post. It was causing confusion so from now on when I put up a new post, I will close the comments on the previous one.
Please keep the questions coming, it gives me an idea what people are thinking and what to write about.
The week ahead . . .
Right now, the futures are up, so hopefully we will have a good week. Fingers crossed.
Heather
13 thoughts on “The MACD”
Heather, the SPY > 200-bar… are we running for the hills or just putting on our sneakers? -Doug
Hey Doug, what ghastly 2 days.
AS you point out, SPY has closed below the 200 SA, first time since March. Not very reassuring. However, 2 things to watch: 1. support at $420 MAY hold, and 2. it was triple witching. I need to go and look at the intraday chart, I will put it in the blog this week.
Re heading for the hills – not yet . . . but defiitely don’t take those sneakers off!
h
Good Morning,
I purchased both your Bull and Bear Books this weekend and found them a quick enjoyable read. However, I do have a few questions. Did you use Walk Forward Optimization to arrive at your parameters? Why did you not use SPX; at least to test the validity of trading for an extended period. The data goes back decades and it tends to be more stable. I no longer subscribe to Amibroker but they did offer excellent Walk forward capabilities. Like yourself, I have been at this for years and have the grey hair to prove it. SPY is still a baby. It was not around for the 1987 crash. An extended Bull Market caused by QE can skew results. I am old enough to remember the Dow bumping against 1000 at least three times. Don’t have an answer for you but I did eyeball the SPX on TradingView using their deeptesting feature. Profitability does wane the further back you go. Thanks for a great BLOG!
Hey Sherman – thank you for your kind words – really appreciated.
Why did I choose the parameters I did? I used my own spreadsheets with daily data going back to 1993 to check out various combinations of indicators, then zero in on the ones that have the best performance. When I have decided which ones are most promising, then I manually step through the charts (yes, it takes forever, but I feel that I need to do it to confirm my figures, and also to see that everything I am suggesting is visible and possible)
So no, haven’t used the walk forward optimiser.
Re QE – yes, aware that it can skew results, but there is no point waiting for it to stop! We have to deal with what is there. We’d all love a nice, predicatble market with not surprises or unknowns – but I guess that has never been the case.
And the 1987 crash – I remember it happening, but I wasn’t in the market at the time – I can remember being at a dinner that night, and there were a lot of very shaken people who couldn’t stop talking about what had happened, but I didn’t really understand it. Possibly that was what piqued my interest in the first place.
Hope I have answered your qustions, if no please get back to me.
I was wondering if you knew of any FREE back testing software that is easy to use. I use TC2000 for my chartwork but it does not have a good back testing option. Many years ago I used MetaStock, but it got too expensive so I dropped it.
Thanks,
Dave
HI Dave, sorry I don’t have any backtesting software that I can recommend. I have had a look, but was not impressed even with the paying ones. I used to use Metastock way back – actually, I think I started using it in 1998! (Good grief, am I really tht old??) but stopped around 2000, started using Bourse, then a few other things now I use OptionGear. I keep thinking I should look for something cheaper (its $50 per month) but it does everything I want and I am used to it. It has no backtesting capability that i am aware of.
I set up my own backtesting – usually using Excel to do the first pass of checking ou if a strategy seems promising, then manually (by eyeballing the charts). Here’s the link to a blog post that discusses it: https://heathercullen.com/waves-or-tide/
I may do some more on it in the next blog, although it is not very rivetting.
Hope that helps.
h
h
I was wondering if you could share “how” you backtest ?
The over-trading is tempting and I would like to be able to do backtesting to be confident in the results and consider them for the lifestyle I am trying to set up (living off options trading and travelling).
Dan
Hey! Backtesting is FUN (eye rolling emoji)
OK – being serious now, there are 2 ways you can backtest:
Automated – so the normal way is to use a spreadsheet, using historical data that you can get from several places (I use Yahoo SPY Historical data – just google it, it is free), set up your decision points using SMA / EMA crossovers, MACD, RSI, etc (whatever indicators and parameters you choose) then muck around in excel until you get the formulae correct (hint: I have found Chat GPT excellent for helping with the coding: if a formula doesn’t work I copy it into Chat GPT and it corrects it for me – brilliant!). Make sure that rather than go just for the buy and sell signals and dates that you use actual data for getting in and out (and also think of the practicalities – if, for example, there is a death cross the earliest you can buy is the next day so use that data) and the effect on your account.
Manually, by creating your system and then eyeballing the charts, stepping through day by day and noting the actions you would have taken. In my view, when you have identified a system that looks like it works via the automated process, then check it manually. I covered the manual process in a previous blog, here’s the link: https://heathercullen.com/waves-or-tide/.
I should warn – backtesting is a rabbit hole – you spiral down into it and don’t want to get out. Been there soooooo many times. But once you get back out you are glad – the sky is so blue, and the sun is so bright!
market breadth spoke loud and clear today while aapl sat on the sidelines. finally the long end of the yield curve is convincing the fed to back off and let Q4 earnings, consumers, and GDP lead this bull up the stairs. we all need to thank Heather for 30 yrs of hard work. she has gifted us the ITM strategy. jan 26 gave us a ITM buy and spy 460 by year end is possible and anything less than a death cross is still a profit.
ron
Thank you! I only wish I could make the market do what I want!!
h
I’m not a MACD expert, but I read this interesting article last week. Would love to know your thoughts: https://relaxedtrader.com/macd-trading-strategy/
As always, thank you for another great blog.
Ronny
Hey Ronny
just had a quick read of it – don’t want to reply off the top of my head. Will revisit tomorrow and post here.
thanks for bringin it to my attention!
h
OK, I watched his video a couple of times – and had to go and pour myself a glass of riesling so that I could watch it a third time.
My thoughts are, firstly, irritation that he doesn’t say exactly what he is doing – we are left in no doubt about his feelings, but his actions are unclear. He shows 2 graphs, both with green dots – and using the tradition MACD settings most of the dots are at the top of curves, and in his ‘reverse’ MACD there are a lot more dots, and they are all on up curves.
My first thought – if there are 230 trades over 30 years that means the MACD line crosses over 230 times – shouldn’t there be the same number of trades for getting in and getting out? How come there are so many more for his ‘reverse’ strategy. If there has been a buy signal then there should have been a sell signal before the next buy – how come the numbers don’t match? He apparently has 100 trades where there are no buy signals but there are sell signals – how can that happen?
The programming uses the code to buy or sell, but doesn’t use any market data. How do we know what he bought at and what he sold at? His ‘system’ is just using the MACD to generate a ‘buy’ of ‘sell’ signal – that’s not trading. You have to look at what you bought at and what you sold at.
In other words, in backtesting you have to actual make the trades, buying and selling and checking the effect on the account. It is easy to say, for example, there’s no better than chance that this trade is going to be successful – but you can still win overall if you make twice as much on your winning trades as your losing .
I DO agree with his assertion that you shouldn’t take anyone’s word for it – you should check for yourself, which is what I am doing. Be your own tester – no argument with that!
I have noted his other ‘swing trading system’ and tomorrow I will have a look at that.
Thank you for bringing this to my attention – it reinforces my idea that someone should be transparent and expose exactly what they are doing and why. Even if it has been the worst years possible to do it!
On the other hand, it was a very nice riesling! Going to have another!
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