The accuracy of analysis methods using either mathematical
modelling or technical indicator should be reviewed from time to time. Today I am going to reviewed the accuracy of
MACD divergence indicator, one of my favourite technical indicator. The detail of using MACD divergence was
discussed thoroughly in previous article (Read
more here), this article will review its accuracy using a real world
example.
I started to monitor FLBHD (Focus Lumber Berhad) on
23-Aug-2016 as the stock price plunged to new low but its MACD indicator did
not make new low. This scenario is
classified as “MACD divergence trending”, an encouraging sign that a reversal
may happen soon.
On 1-Sep-2016, the stock price hit the lowest point at
RM1.42, and then it started to recover. At
that point, the MACD indicator did not register new low so the “MACD divergence
trending” was still intact. The critical
valley 1, 2 and 3 were forming thus the chances of achieving “MACD divergence
confirmation” was high.
On 9-Sep-2016, the MACD line finally cut above the signal
line, indicating that the MACD divergence was formed thus I bought 1,000 shares
of FLBHD near the closing bell at RM1.50 based on the following rules.
|
Rule
|
Description
|
Price/Level
|
Comment
|
|
1
|
Entry point
|
RM1.50
|
MACD Divergence confirmation
|
|
2
|
Stop-loss point
|
RM1.42
|
Lowest price point that coincide with MACD line level near
valley 3
|
|
3a
|
Exit point 1
|
RM1.68
|
Lowest price point that aligned with lowest MACD line level near
valley 1 (Yellow arrow in Graph 1)
|
|
3b
|
Exit point 2
|
See comment
|
Any price point as long as MACD line crosses zero level
|
|
3c
|
Extended exit point
|
See comment
|
If the price breakout from downtrend line (blue line in Graph 1)
before hitting criteria 3a and 3b, ignore the criteria 3a and 3b and readjust
the exit point per trend line and wave count analysis.
|
|
4a
|
Potential Positive return
|
12.00%
|
[(exit point 1)/(entry point) -1]
|
|
4b
|
Potential Negative return
|
-5.30%
|
[(stop-loss point)/(entry point) - 1]
|
|
4c
|
Positive return probability
|
70%
|
Based on historical observation
|
|
4d
|
Negative return probability
|
30%
|
Based on historical observation
|
|
4e
|
Expected return
|
6.81%
|
E(R) = (positive return probability)*(potential positive return)
+ (negative return probability)*(potential negative return)
|
After I bought FLBHD, the stock price moved lower to RM1.47 on the next few days. As it did not go below the stop-loss point, I continued to hold the stock. Then, the stock started to edge upward on the 4th day then moved backward after hitting the downtrend line.
On 10-Oct-2016, the stock price broke out from the downtrend
line before the MACD line crossed zero level.
As such, both rules 3a and 3b were void.
The new exit point will be based on trendline and wave count analysis, which
will be covered in another article.
MACD divergence is a good technical indicator for trading as
it provide very clear entry, stop-loss and exit points. This helps to create a robust trading system that can be followed easily. My long-term plan
is to code it into an auto-trading application and let the system run by
itself. Feel free to contact me if you
are interested to co-develop the software.
Happy trading!
Graph 1
Picture 1
Picture 2
Disclaimer: The above
analysis does not imply any buy or sell recommendation. The author
disclaims all liabilities arising from any use of the information contained in
this article.
Disclosure: The author
may have interest in the stocks of the companies in this article.
