MACD Divergence accuracy checkpoint

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 4^th 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.