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.
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 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 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.
The VIX has climbed quite a bit, but lets keep it in perspective. Technically, we are still in a low-volatility period.
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.