I cut my teeth on technical analysis the first ten years or
so I studied the markets. Technical analysis fascinated me…to be able to
predict future price action was just too much of a temptation to resist…chalk
it up to human nature I suppose…I was searching for the magic indicator that
would solve all of my trading problems. It took me all of those 10 years to
discover that one, the magic indicator doesn’t exist and two, I wasn’t cut out
for short-term trading. I did pick up a few things though…The most important being that technical analysis comes into its own
when applied to the underlying breadth of the stock market. I studied the
McClellan Indicators and kept them up in my own spreadsheet. They were good but
I kept on experimenting…in time I
started to apply the basics of the MACD indicator to the advance/decline line
of the NYSE (common stock data only). I used the same parameters the
McClellan Summation Index used…The indicators were similar but the scaling was different and I preferred my version of tracking momentum of the NYSE’s breadth...It took me a few more years to properly interpret this indicator
as I was still learning about the market and I had to get my own psychological house in order...psychology is probably 95 percent of investing.
The MACD is a type of
momentum indicator referred to as a ‘trend deviation technique.’ I essentially
took a 19 and 39 day moving average of the cumulative adv/dec line of the NYSE and
subtract the longer ma from the shorter one and viola…my breadth indicator took
its first breath…I almost felt like Dr Frankenstein in the original
Frankenstein movie. The indicator is very similar to the McClellan Summation Index
but I much prefer the scaling of my own indicator which is a ratio-based
indicator. If you don’t know what that means, look it up because I’m getting
impatient and this post is already getting too long.
Both the direction
and the level of the indicator are equally important. I read years ago that
Martin Pring claimed that, support and resistant levels as well as trendlines
and chart patterns can be applied to momentum indicators. In my experience I
have found that to be true but I don’t usually use the indicator in that
fashion.
I use it primarily as
an overbought/oversold indicator…Every four years or so, the market will sell
off to a prominent low. All the holders
of stocks liquidate their positions in a panic resulting in a capitulation-like
low that sticks out like a sore thumb on this indicator...it will be
followed by a strong impulse wave up from the low marking the beginning of new
market up-trend…After a few years this indicator, though still above the all-important zero line, will run into
resistance at the 50 percent level. This will never look exactly the same
but it can be clearly observed in the
chart that the indicator is topping out at a lower level than the previous few
years. This is the time to trim or sell-off your holdings but it will be
difficult as the news will be glowing and everybody and his brother will be
running around buying stocks and wanting to talk about it. The media makes an
excellent contrary indicator at this time as they hype-up all the buying
activity going on in stocks...totally oblivious to the waning momentum of the underlying market.
More to follow on my next post…
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