|Using Complimentary Indicators: MACD, Moneyflow & CCI|
Using Complimentary Indicators: MACD, Moneyflow & CCI
Please note that we have used historical data. These examples are for educational purposes only.
In this issue of ChartFilter we'll look at the use of a complimentary set of indicators; MACD and Moneyflow, with the assistance of CCI. MACD is a trend following indicator, and often able to capture the majority of the move when a significant trend develops. As a trend following indicator, however, MACD sacrifices early signals in exchange for keeping you in line with the trend. When the trend is short lived MACD often proves unreliable.
The moneyflow indicators (Money Flow Index [MFI], On Balance Volume [OBV], and Price Volume Trend [PVT]) track the flow of money into or out of a market. Price typically follows moneyflow and will eventually move in the same direction. These are considered leading indicators of future price movements, and therefore perform in a complimentary fashion to many of the other indicators, including MACD and CCI.
CCI is usually used as an overbought/oversold indicator, and can also be used for timing buy/sell signals.
CURRENT TRENDS - Learning from current markets
Today's markets are not only volatile, but they're downright brutal -- and generally downtrending. It's difficult to make money (and hang onto it!) even in the best of markets - but when the majority of stocks are going downhill, the going gets even tougher.
The only way to make money in these markets is to be psychic and patient. Well - not quite, but you get the idea. You need extra discipline and a reliable set of tools to get you into the money and keep you out of hot water. The MACD & Moneyflow combination is one system that can provide good insights into specific stocks and can assist you in catching trends as they develop. Let's see how these indicators can be applied to specific stocks...
In the chart below, I've plotted Tellabs (TLAB) along with MACD and MFI. For this set of indicators I find the following trading rules can be very useful:
As shown by these charts, you can see that the MACD oscillator is very useful for capturing the bigger moves, and MFI often provides valuable assistance. Using this system you would use MFI to either confirm or override MACD; that is, when MFI is trending downwards or sideways, you would ignore MACD buy signals. Personally, I recommend waiting until both of the MACD oscillator lines cross the Zero line before taking action based on the buy signals. As you can see from the above chart, you might be wise to sell an existing position when the MACD histogram goes from positive to negative.
This system isn't foolproof, however (unfortunately, they never are!). Let's take a look at another stock using this system; Cienna Inc (CIEN).
In the chart above, the first buy signal was accurate, however the second buy signal would have been misleading, even though the MFI was uptrending. This confirms the statement at the beginning of this newsletter -- when the trend is short lived MACD often proves unreliable. Thus, I recommend using a third indicator - CCI - to provide further insight. Here's CCI plotted for the same stock (CIEN).
Compare the MACD and MFI charts with the CCI chart. CCI is a commonly used overbought/oversold oscillator. Generally speaking, you use CCI to warn of an overbought condition when it goes above +100 and an oversold condition when it goes below -100. For the sake of this combination of indicators, we consider whether or not the latest signal offered by CCI confirms the other two indicators. If CCI makes a sharp dip below -100 and then back up through the zero line, we consider this a buy signal (and vice versa).
You can see in the charts above, that the CCI indicator did confirm the first buy signal and the sell signal in the middle, but not the second buy signal (marked Pt A on CCI chart).
So, we can add a fourth trading rule to our system:
I recommend you experiment with these three indicators on your own. Plot the MACD oscillator and histogram and compare the signals with those offered by the various money flow indicators (MFI, OBV, & PVT). Then, once you've found a combination that seems to work, use CCI for a final confirmation (or rejection) of the MACD and moneyflow signals.
TIPS & TECHNIQUES - Using this combination of indicators
MACD is a trending indicator, telling us whether a stock is in an uptrend or a downtrend. As I've written on many occasions, the direction of the long-term trend is the first assessment you should make for any market. If it is trending up, you want to be buying. If it is trending down, you want be selling.
MFI, PVT, & OBV: The Money Flow Index was developed as a real-time variation on the On-Balance Volume indicator. Instead of using each day as a reference point (as OBV does), MFI analyzes each trade. And instead of ignoring the price or the amount that the market is up or down, MFI weights each trade by price.
Although the interpretation of PVT is similar to the OBV and the Accumulation/Distribution indicators, PVT more accurately demonstrates the flow of money. PVT adds only a proportional amount of volume to the indicator, whereas OBV adds the same amount of volume not considering whether the market closes up a fraction of a point or triples in price.
CCI was designed to identify the beginning and the end of market cycles. It indicates the price is increasingly high compared to average prices as it moves towards +100. As the CCI drops towards -100, it indicates that the price is increasingly low compared to average prices.