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Coach's Corner: Using MACD And Taking the Long View

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January 1, 2013

If the market were the Old West, right about now you might be “shooting from the hip,” reacting to anything that moves, and every market whim. But hold on there, trader. You now have electric can openers, as well as time to identify your target, take aim, and fire more thoughtfully. From a technician's perspective, looking at longer-term charts may also help you zero in before you pull the trigger on shorter time frames. Let's walk through an example of a bullish entry.

What's on the Wanted Poster?

Sometimes the best way to identify your target is to find higher ground. In technical analysis, this means looking at a longer aggregation period than the one your trading signals come from. When using a daily chart for example, by comparing to a weekly chart, you eliminate insignificant daily movements and may see the direction more clearly.

Even from this hierarchy, applying a moving average to the chart can make things clearer. For example, Figure 1 uses a thinkorswim® chart, with a 26-week Exponential Moving Average (EMA). Though you may have a rising EMA, indicating bullish conditions, the stock still retains its cyclical behavior. As a result, notice the momentum is turning in your favor. For this purpose, we'll use the MACD Histogram set to the default (12,26,9) setting. A rising MACD shows the momentum is turning in the direction of the longer-term trend.

Multiple time frames

FIGURE 1: SECOND OPINIONS.

When sizing up a trade, using multiple time frames to confirm a trend, such as the weekly (left) and daily (right) charts of SPX, can help time entries (and exits). Chart from thinkorswim. For illustrative purposes only.

Aim Well

At this point, you're really trying to zero in on which day to enter the trade, using a daily aggregation period. Assuming you've identified your target correctly, you're going to key off the Slow Stochastics, using a (7,3) setting, with the “overbought” and “over sold” areas set to 70 and 30, respectively. Assuming the weekly MACD is still moving in the direction of the trade, an entry signal is based on the Slow Stochastics trading below 30 for a bullish trade, and above 70 for a bearish trade. With the long-term momentum turning bullish, and the short-term momentum at a bearish extreme, the stock may be poised for a move back in the direction of the long-term trend.

Fire When Ready

With a rising 26-week EMA, a rising MACD histogram on the weekly charts, and the slow Stochastics moving below 30 on the daily charts, the stock is in a position to enter an order (see table). The trading trigger could be pulled using a buy-stop order of say, $0.20 above the previous day's high. A protective stop could be placed initially 1-3 % below the low of the previous day or the entry day, whichever is lower.

MACD Direction Indications

For illustrative purposes only.

In a dusty barroom or on the trading floor, the best man almost always wins. Lining up your trade using multiple time frames may help give you a clearer view of your target—making sure you're trading in the direction of the longer-term trend.

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