The McDonald’s Indicator

Tom Gentile

Posted in
Education

By: Tom Gentile
January 26th, 2024

4 mins read

No, it doesn’t have anything to do with a Big Mac, Quarter Pounder, or Chicken McNuggets. I’m talking about a technical analysis indicator we call MACD.

MACD stands for Moving Average Convergence, Divergence. It’s a very popular indicator for trend analysis.

What is the MACD Technical Analysis Indicator

The MACD can be interpreted in a number of ways – as a trend confirmation indicator or as an overbought/oversold (trend reversal) indicator. Below is an example of the latter:

MACD Trend Reversal Indicator
MACD Trend Reversal Indicator

As you can see in the chart above, the first signal is indicating a “Sell” in overbought territory.

The second signal can be interpreted as an indication to “Exit” a short position in oversold territory, or a new “Buy” signal – or both.

The third signal is a new “Buy” in oversold territory…followed by the fourth to “Exit” a long position.

As you can see, the MACD when used properly, can be a great indicator of the projected trend direction.

One challenge with MACD as a trend reversal indicator is that it can often signal a reversal, but then no reversal actually occurs. If you look closely at the chart below, you can see that situation in between the two Buy signals.

Trend Reversal Signal Between Two Buy Signals
Trend Reversal Signal Between Two Buy Signals

This is the problem with most oscillator type indicators. A way to overcome this issue is to combine the MACD with trend following indicators. Two such indicators are the DMI (Directional Movement Index) and the ADX (Average Directional Index). We will look closer at these types of indicators in later editions. You can also use additional non-related technical indicators as confirmation of what the MACD is telling you.

Another way to use MACD is to spot divergences on a price chart. Have a look at the IBM chart below…

IBM chart Depicting a Bullish Divergence
IBM chart Depicting a Bullish Divergence

When price is making a lower low…and MACD shows a higher low, you have Bullish divergence setting up a trading opportunity to buy the stock, or better yet, buy Call Options.

Depicted Bullish Move
Bullish Move Depicted

Using MACD divergence works just as well for Bearish opportunities.

Bearish Divergence Depicted
Bearish Divergence Depicted

When price is making a higher high…and MACD shows a lower high, a Bearish divergence has been formed. A great setup for taking a Bearish trade by shorting the stock, or better yet, buying Put Options.

Image 46
Bearish Move Depicted

Let’s Re-Cap What We’ve Learned

  • The MACD line is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.
  • The signal line is calculated as a nine-period EMA of the MACD line.
  • The MACD’s traditional settings of 26/12/9 periods are the norm. As with most analysis tools, these settings can be modified.
  • MACD triggers a “Buy” signal when the MACD line crosses above the signal line.
  • MACD triggers a “Sell” signal when the MACD line crosses below the signal line.
  • MACD can help determine if a security is either overbought or oversold. It can also alert traders to the strength of a directional move, and/or a warn of a potential price reversal.
  • The MACD indicator can also alert traders to Bullish & Bearish divergences such as when a new high in price is not confirmed by a new high in the MACD, and vice versa. These divergences may suggest a potential trend failure and/or a trend reversal.
  • After a signal line crossover occurs, it’s recommended to wait for 3 or 4 periods (days on a daily chart) to confirm that it is not a false move.

In closing, the next time you drive by your local McDonald’s you can think about making money in the stock market using the MACD indicator – just a thought…

Until then – Trade Safe and May the Profits be with You.

Tom Gentile
C1P: Chief 1-Percenter

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