Saturday, January 22, 2011

MACD Sell Signal For The Qs

We now have a valid MACD negative divergence sell signal for the Qs, but what was wrong with the last one?  This is where a little observation can keep you out of trouble.  First, on the day of the last signal the Qs closed near the top of the day's range.  Second, the volume was anemic.  And third, there was no downside follow-through to confirm the signal.  And lastly, neither the SP500 nor the Russell 2000 had valid sell signals either.

This time we have the Qs closing at the low of the day on higher volume, and we already have a valid MACD sell signal for the Russell 2000.  The only thing lacking is downside follow-through.  In order to enter a position, we would want to see the Qs break and sustain below the trendline from the November low.  In all likelihood, we will see a defense of the trendline on Monday or an apparent false break with the Qs breaking below and then closing at or back above the trendline.  In that case, it would be prudent to wait for a break of Monday's low to enter a short position.  If, on the other hand, the Qs fall by 1% or more on increasing volume Monday, then it would be acceptable to enter a short position.

Typically, traders will put a stop loss in just above the previous swing high, but using the MACD the rule is that the trade is still in force as long as the MACD doesn't rise above its previous high.  You still need to make sure that your position sizing is within acceptable limits for your account.  What if you took the previous MACD sell signal as a signal to go short.  Then, you should still be in the trade as the MACD has not risen above its previous high.  Of course, you would have had a 4% to 5% drawdown, but that is not extreme.

This seems to go against the usual admonition for traders to NEVER go against the trend, but the fact is that trends do change and the MACD is one good way to observe when that is happening or about to happen.  However, it must be used in conjunction with a good understanding of market behavior and some common sense rules.  Last year, using the rules presented on this blog, the MACD made 16% trading the Qs with only 3 trades (2 winners and 1 loser).  This is why it is one of my favorite tools.

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