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'Tis Better To Light a Candle Than to
Curse the MACD
 Let
us insert our tongues firmly into our cheeks and take a little trip out to the
wood shed where we shall administer some necessary and long overdue medicine to
a most revered technical indicator.
No doubt you've heard the expression 'tough love.' Here we go a step farther and
deliver a technical trading reality slap!
Due to our fond affection for the ephemeral pip we will be directing our remarks
to Forex traders, however these comments would apply equally well to traders of
other markets, be it baseball cards, beanie babies or stocks.
We're here to skewer a sacred cow; that holiest of holy technical indicators,
brought down from Mystery Mountain on the same tablet as the slow stochastic,
but that's an article for another time.
We're speaking of the venerable Moving Average Convergence Divergence or simply
MACD.
Enough articles have been written about the MACD to repopulate half the world's
rain forests. Perhaps this will be the last. Although given human nature we'd
have to forecast (without using the MACD) that more trees will needlessly die.
Here it is with both barrels: the MACD doesn't work. It's a glorified (if more
complex) moving average, and moving averages are pathetic in forecasting price
direction. They're great for telling you where, how and when price has already
been -- but that's in the past, and there's a reason why they call this
futures and not histories.
When applied over a long enough time frame a given moving average will be right
half the time and wrong the other: the very definition of randomness. Jimmy the
Greek would take a pass.
It's true that when paired with a second moving average of differing and
reasonable periodicity (3:1, 4:1, 5:1, etc.) it is possible to maintain a modest
positive trading expectancy over a sufficient number of trades, but a pair of
endlessly crisscrossing moving averages will 'get you in' too late and just as
often 'get you out' even later the vast majority of the time.
The MACD is a seductive indicator: by eschewing the simple moving average in
favor of the exponential it is just advanced enough to entice the delight of the
technically-minded, but not so arcane as to perplex the most propeller-driven
beanied amongst us.
As for sex appeal, it's got two colorfully wavy lines crossing back and forth
over each other (that's to keep you hypnotized), plus this really cool histogram
in the middle for an added air of sophistication. Of course, you could program
charting software to reprint the physical separation between any two
moving lines, but so far only the MACD holds that claim, and it's an attribute
that fascinates.
But the true allure of the MACD is that it requires -- ta, da! --
interpretation. This fact alone has guaranteed the MACD perpetual
placement in the pantheon of trading studies. For once a thing can be
interpreted, it can be elevated to mystical status. From there it's just a short
trip to worship which is where the MACD finds itself today.
MACD apologists would argue that we're being too harsh. That looking back there
are countless times when the venerable work horse presaged a profitable move. No
doubt. Of course that would also be true of tea leaves, drifting clouds or a
spinning Coke bottle. Even a stopped clock is correct 730 times a year.
Alas, when used as an entry signal to the lush pip-filled world lurking just
beyond the hard right edge of our computer screen, the MACD fails time and again
as one would expect from any mathematically AVERAGED smoothing of PAST price
action.
If only one could trade in reverse!
Those inclined to count how many pips can fit on the head of a pin might wish to
tweak their MACD in an attempt to make it even more 'predictive.' To our way of
thinking this is like feeding a variety of performance enhancing drugs to a
snail and watching to see if its meandering trail bends just a little more to
our liking. But would it help us to know where the snail is going next? No, we
won't have a clue, and the snail probably won't either.
The MACD uses as its farthest backward looking value 26 periods. On a 15 minute
chart, 26 periods total 6 hours and 30 minutes. Fifteen minutes goes by pretty
fast. There are 96 such periods in a 24 hour day, 480 in a 5 day trading week. A
single period of 15 minutes is really just noise in the larger scheme of things.
Let's say it's 8:00AM New York time and I'm sitting here watching the 15 minute
chart. What is the MACD doing? Still paying attention to what happened back at
1:30AM when New York traders were sawing wood.
I'm sitting here trying to get pips based on where I think the market is going
in the next 15 or 30 minutes. I'm trying to get pips RIGHT NOW. What do I care
where price was trading SIX AND A HALF HOURS AGO?
My favorite pair may have traded above the daily pivot during the Asian session,
taken a bounce off strong long term resistance on the London open and dropped
like a rock right into the New York session, leaving the MACD looking like a
drunken hula dancer trying to outrun a volcano.
But I'm trying to divine what the Big Boyz are likely to do in the next 15 to 30
minutes, which means I need to understand what they were thinking 15 or 30
minutes ago, not in the middle of last night!
What I need is a predictive, laser-guided aiming system. What I get instead is a
meandering lava flow with a bunch of crazy people trying to stay one step ahead.
(Fortunately, most of those sprinters are serial pip donors, so I encourage
their efforts and offer them a glass of water as they run by!)
In the end, the performance of moving averages and indicators based on moving
averages will always be, well, average. So let's move on. What can we use to
tell where price is going next?
Hah, I caught you. The answer is: nothing. There is nothing in existence that
can tell us where price is going next. But there are a few simple tools that can
tell us where price is likely to go next, perhaps 80% of the time or
better.
They are:
1. The trusty trend line.
2. That freshest of all price footprints in the sand (or snow, depending on
where you live): the candlestick.
These tools are not sophisticated and require no divinity degree to 'interpret.'
In fact, they are not subject to interpretation. They are that stupid. They just
sit there and look at you. And you look back, and you know what to do.
Don't believe me? [Using a demo account] try removing all indicators except for
support and resistance (trend) lines and candlesticks. Here is a short list of
what you do NOT need:
1. Moving averages
2. Stochastics
3. Parabolic SARS
4. Bollinger Bands
5. Chaos fractal alligator
6. Ichimoku ginko biloba
7. Fibo-tunnel price-ray vectors
We have learned to recognize that price is a fickle thing that can change its
mind faster than Liz dumped Dick; that price moves like the people who move it.
That like Sherlock Holmes who could walk into a room and know instantly how the
killer had left.
(Answer: Through the window. The
candle on the table next to the window had been burning. A breeze had been
blowing into the room. All of the dried wax had dripped down the candle opposite
the window. The window had been open and that's how the killer had escaped).
First and foremost, learn to recognize
candlestick action. We can look at a candlestick and instantly see telltale
marks of reversal and rejection (fear!), or momentum and continuation (greed!)
that drive markets.
When candlestick reversals occur at places where fear and greed occurred before
(tilted support or resistance = trend lines), or at anticipated price levels
(horizontal support or resistance = pivot points), we have an extraordinarily
high probability trade.
Price zigs ... a hammer at key support!
Price zags ... an evening star formation following a tweezer top at key
resistance!
And the MACD?
Still meandering through the charts like a
picturesque mountain stream, 'weaving through the canyons of your mind.'
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