Minimize the “noise” by learning about long term indicators like the MACD

September 11, 2011 / Karen Smith

One day our Dow Jones Industrial Average (^DJI) is up 150, the next it’s down 200. Triple digit moves seem to be the order of the day here in the late summer 2011. What is the bottom line result? Lots of volatility in a choppy trading range. What is a trader to do? It’s enough to make you feel that you are riding California Screamin’ at Disneyland – only that’s a lot more fun!

Sometimes it is beneficial to look at longer term technical indicators for the market to remove this choppy “noise” we have in our daily trading environment. I am a frequent viewer of CNBC, and I saw a very interesting interview about looking at a long term view of our MACD ( Moving Average Convergence Divergence) for the S&P 500. Remember that our MACD is a momentum indicator that shows if the trend of the market is strengthening/weakening across time.

We know from experience that markets that trade in a range for a period often break out of the range forcefully in one direction or the other. Determining the direction of the breakout is often the challenge. Perhaps this long term indicator might be helpful. When you pull up a long term (10 year) chart of the S&P 500, you will see that the MACD measured on a monthly basis has had important historical crosses. After the events of 9/11/2001, we entered into a falling market that lasted until the spring of 2002. In April of 2002, the monthly MACD showed a bullish cross as the MACD crossed the signal line. This started a bullish trend that ran until late 2007. While there were periods of pullback during this long bullish run, it is definitely a chart that goes from the lower left corner to the upper right!

In December, 2007, the monthly MACD crossed from a relatively flat position under the signal line, indicating an upcoming bearish move in the market. What a bear market it was! Had you heeded this one simple indicator, you would have at minimum avoided the unbelievable downturn of 2008 or, with the type of knowledge we share at OptionsANIMAL, you could have profited dramatically from the bearish market that ensued through the spring of 2009.

The MACD remained bearish until August, 2009 when it finally crossed again to the bullish side. While our market technically bottomed in March of that year, it took the MACD a little time to “catch up” to the price action. Once it crossed, it marked the beginning of a bullish run that has taken us to today.

Notice our MACD indicator today in September, 2011. The MACD has fallen to the level of the signal line, showing a “pinch” at the moment. While we don’t yet have a bearish cross, with a bearish September we could have such a cross. Prudent investors will want to watch this situation closely for any further deterioration in this indicator.

Karen Smith
OptionsANIMAL Instructor