Using the MACD Indicator - Part II

For more great setups like the ones described below, you'll want to try one of Dr. Stoxx's market letters (CLICK HERE).

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As I explained in a previous blog, the MACD technical momentum indicator uses two exponential moving averages to render a visual picture of times when those moving averages are either converging on or diverging from each other. The changing posture of these two moving averages relative to each other gives the market technician information that can be used in rendering judgments about where the security might be heading in the near future.

In that blog, I showed how you can use the MACD to identify uptrends and downtrends of various strengths, and when it is best to buy or sell the market. In this article, I’m going to show you a simple MACD trading system that you can use to find very robust setups. This particular system works best on the long side of the market, so we will focus here only on buy signals.

The MACD signal I use to pinpoint the best entry in the stocks I buy is rendered when where there is divergence seen between the security’s price and the value of the indicator. Divergence can mean different things to different analysts, but here is how I define it (using only the long side of the market):

  1. The security’s price prints two pivot lows in price over a period of time, the second low being as low as, or lower than, the first low
  2. Each pivot low is well defined by a downtrend leading into the price low, and an uptrend following the low
  3. There is significant time between the two lows (at least 10 bars of price action should suffice)
  4. The indicator – in our case, the MACD, but any momentum indicator can be used – prints a higher low in correlation with the second price low

With divergence now defined, let’s look at some examples. I happen to like and own shares of Tesla Motors (Nasdaq: TSLA). This year I made two purchases of the stock: the first in mid-January at a price of 190.67, and the second in late-March at a price of 189.45. Today my shares are trading at a price of 230.03, a full 21% above entry. As you’ll see below, I used the MACD-divergence system to time my two buys. In the highlighted setups, you will see clearly defined pivot lows, the second being lower than the first (they can also be roughly equal), coupled with a higher low in the MACD indicator.

tsla1

TSLA Stock with 2 MACD-divergence Buy Signals

I like the cybersecurity space right now and one of my favorite stocks in that industry is VASCO Data Security (Nasdaq: VDSI). I initiated a position in the stock recently when it printed a triple bottom on the price chart over two months. A triple-bottom is a good place to buy in any case, but when you see divergence in the MACD indicator as well, you can buy with confidence. I purchased shares on the second dip under $22 in early April, because at this new low, the MACD did not dip as far as it did on the first two lows (in January and March). Here we see three price lows of roughly equal value (not lower lows) coupled with a corresponding MACD indicator that is making higher lows on each dip. Either the March or April low qualifies as a great place to buy shares. My position off the April low is now showing a profit of nearly 20% in about a month's time.

vdsi1

VDSI Stock with 2 MACD-divergence Buy Signals

I’m also a fan of solar stocks. While 2014 was a rough year due to dramatic price cuts in solar panels and equipment, the industry is in rebound mode this year. The ETF that tracks publically traded solar companies (NYSE: TAN) is already up +40% year to date. One of my favorite stocks in the space is Canadian Solar Inc. (Nasdaq: CSIQ). Canadian Solar was the #1 best performing stock in 2013, and here in 2015 it looks set to have another great year. I purchased a small “starter position” right at $20 even back in late-January. That was when the price chart printed a third lower low but, for the first time in that sequence, the MACD printed a higher low. Four days later, news hit the wires that CSIQ had acquired a competitor company causing the sharp spike in price that you see on the chart. My shares are now trading +82% higher in a little over three months.

csiq1

CSIQ Stock with a MACD-divergence Buy Signal

That’s all for now. For more great setups like this one, you'll want to try our market letters (CLICK HERE). I pinpoint MACD-divergence entries like this nearly every market day in either stocks or ETF's.  

Posted to Dr. Stoxx Options Letter on May 04, 2015 — 3:05 PM
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