SCOTT WELSH TRADING BLOG

Is MACD The Magic Tool?

Is MACD The Magic Tool?

October 10th, 2018

There have been a handful of trading books that have strongly influenced my trading journey and Rule #1 by Phil Town was one of them.

Although the prose can be a bit corny, the message resonated with me: Regular people can trade-for-a-living.

The bulk of the book is spent on value investing and how to do it. Mr. Town likes to “buy good companies at good prices”, which is something we’ve heard many times in many places. But Rule #1 was one of the first books to bring that concept to the mainstream.

Toward the end, Rule #1 admits that, after finding a good company, buy-and-hold investing is nearly impossible. I agree. The chances of someone buying Apple in 2004 and holding it until today are slim and none, and slim just fell off a cliff. The emotions of holding a winning stock through a 50%+ drawdown are too much for anyone.

So Town then gives us the secret sauce. He teaches us his “Tools”.

His Tools are simply off-the-shelf indicators, and the first one he describes is MACD.

Instead of trying to hold a stock forever, he shows us that by using a Tool like MACD, we can buy when momentum is going up and sell when momentum stalls. We can take control of our trading and stay in the game long-term.

Again, I agree.

But is MACD really the tool to do it? Let’s find out.

First, it’s really important to know that the stock we pick for long-term trading-for-a-living is monstrously important. Picking a good stock is AT LEAST 50% of the battle (it may be more like 70%). It is unwise to pick any random stock and just slap a MACD on it and expect to retire by Friday.

So we need to pick some good stocks for our study. And we need at least ten years of results to draw any conclusions.

I went back to my stash of IBD newspapers and opened one from November 3, 2008. That’s about ten years ago and it’s right on the heels of the greatest meltdown of our lifetimes. I thought that was a good place to start.

Then I picked the #1-rated stock on the famous “IBD 100”. Some of the greatest stock winners in history have been on this list, so I thought picking #1 was a good idea.

I also picked #2 on the list.

And, last, I picked the first one on the list that was an IBD “recommendation”. This means that it was the highest-ranked stock on the list that was nearing what they determined to be a buying point. (IBD has their own convoluted way of buying stocks, but that’s another topic for another time).

We’ll talk about those two in our emails coming out later this week. Today we’ll stick to #1.

Now that we have our stock picks, I put the MACD indicator on my chart using the default settings. I bought when the MACD went said Buy (histogram moved from negative to positive) and sold when the MACD said sell (histogram moved from positive to negative).

The #1-rated stock on the IBD 100 in November 2008 was EBS (Emergent Biosolutions).

Here are the system details:

  • System: Using MACD to Trade-For-A-Living
  • Philosophy Behind It: As long as you pick the right instrument, buying and selling on MACD momentum is the way to get all the gains and not have the huge drawdowns of buy-and-hold.
  • Need Special Indicator? No. MACD is on everything.
  • Chart: Daily
  • Instrument: EBS (the #1 stock on the IBD 100 in November 2008)
  • Long or Short? Long Only
  • Entry: 1) MACD closes in positive histogram above zero after being negative; 2) Enter at Open of next bar
  • Exit: Sell at Open of next bar when MACD prints the first negative histogram below zero after being positive
  • Indicator settings: MACD (default settings of 12-26-9)
  • Hypothetical Profit: -$5,020
  • Hypothetical Max drawdown: -$9,557
  • Profit target: none
  • Stop loss: none
  • Trade size: $10k worth of stock each time
  • Hypothetical account size: $10,000
  • Test Period: 2008-2018
  • Number of Trades: 105

Well, that’s not good. If we used MACD on the #1-rated stock we would have LOST $5,000 in the past decade or so.

But was our stock pick the reason for the bad results or was it the system?

To find out, instead of buying and selling on MACD signals, I used MACD to enter as usual but then exited after a period of time. Here’s how that went:

  • System: Using MACD to Trade-For-A-Living
  • Philosophy Behind It: As long as you pick the right instrument, buying and selling on MACD momentum is the way to get all the gains and not have the huge drawdowns of buy-and-hold.
  • Need Special Indicator? No. MACD is on everything.
  • Chart: Daily
  • Instrument: EBS (the #1 stock on the IBD 100 in November 2008)
  • Long or Short? Long Only
  • Entry: 1) MACD closes in positive histogram above zero after being negative; 2) Enter at Open of next bar
  • Exit: Sell after 80 bars no matter what
  • Indicator settings: MACD (default settings of 12-26-9)
  • Hypothetical Profit: $17,553
  • Hypothetical Max drawdown: -$7,263
  • Profit target: none
  • Stop loss: none
  • Trade size: $10k worth of stock each time
  • Hypothetical account size: $10,000
  • Test Period: 2008-2018
  • Number of Trades: 25

That’s much better. By not getting out when MACD tells us to, we improve our results and even beat buy-and-hold.

So it wasn’t a bad stock pick on our part, it was a bad system. By using MACD as an entry tool, but not an exit tool, we could have done pretty well, roughly averaging about 1.5% per month over that period (according to Tradestation’s numbers).

It turns out MACD can be an effective tool, just not in the way that was outlined in Rule #1.

The big questions are: How did MACD fare on the other two stock picks and would another indicator have done better? We’ll find out in the emails coming later this week.

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.