Tag: MACD

2 Time Frame Pinch Play with entry, stop and target.

2 Time Frame Pinch Play with entry, stop and target.

I have provided an example of a short sale signal using the 2 time frame pinch play from my book “Invest Like a Pro”. Risk management is of paramount importance when doing trades of this type. In order to be successful over time, you must be very strict about the loss side of the equation. If you just buy because a stock looks like it is going higher or you sell (short) a stock because it looks like it is going lower, i believe you will struggle to be successful as a trader. By refining your timing, you will improve your reward to risk equation which will increase the odds of success. The 60 minute and 10 minute charts of AT&T (T) below show how to improve your timing and entry as well as reduce your risk in a trade.

60-minute chart higher time frame:

Here is an example of how this approach can be used on two intraday time frames.  Above, we see the 60 min chart triggered on the gap down at the open.  If you shorted at the open you would need to put your stop above the peak from the prior afternoon around $24.70.

10-minute chart lower time frame:

I left the circled area from 60 min on the 10 min chart so we can see the timing of the trigger.  The timing and reward to risk equation improves dramatically by moving down to the 10 minute chart and waiting for a second pinch. Notice how the trigger took place before a big extended move.  That is important when the higher time frame qualifies via a gap.  Target was hit by .04 before turning up. So, by waiting for the lower time frame to provide a more timely trigger and stop, we were able to hit a 3-1 reward to risk target in just a few hours.

Pinch Plays

Pinch Plays

Linda Raschke wrote a book called Street Smarts with Larry Connors.  This is a great book.  One of their signals is called an Anti.  They use a different form of MACD or Stochastic to find this signal.  However, the concept is the same.  We want to find when the Signal line has turned or is trending and the MACD moves counter to it.  It causes the two lines to pinch together for a brief period without causing a crossover.  The weekly chart of Apple Inc.  (AAPL) from 1999 shows back to back Pinch signals

after price emerged out of its base.  Typically, price will pullback 2-3 bars or will drift sideways to alleviate the short term overbought condition.

Sometimes these signals will take place following momentum divergence (discussed next) or in conjunction with divergence patterns.  Once again, the best signals will usually emerge when there are signals from the price structure and the MA lines to confirm. 

The chart of Pepsico Inc. (PEP) from 2018 is above.  Price breaks the trendline (step 1) and then tests (step 2).  This process is also the 40 to 18 bounce pattern discussed prior.  During this rally to the 18 MA line, MACD is unable to regain its Signal line causing a minor pinch to develop.  This gives us enough evidence to sell as soon as 18 MA line is re-broken instead of waiting for step 3 or the break of the 40 MA line.  One of the keys to this signal is watching the price action.  Many times, the MACD line will only tighten to the Signal line slightly so focusing on the counter trend move in price helps this pattern to become easier to recognize.  In addition, the first two pinch plays are the highest probability and then the odds start to drop off somewhat due to the longevity of the trend.  In this example, the reward to risk improves dramatically using this entry trigger rather than waiting. 

Zero Line Reversals

Zero Line Reversals

With the MACD indicator, the zero level is where the fast moving line (12) crosses the slowing moving line (26).  In the chart below, I have added a 12 EMA and 26 EMA to the price chart so you can understand the calculation.  As I have mentioned previously, I do not use MA crossover signals as operative buy/sell signals, but they are useful at helping to define the trend.  So, the zero line (highlighted in lower scale with red horizontal line)

signifies the level where these two EMA lines meet and cross one another.  Oftentimes, good signals take place near this level.  The chart below is the same daily chart of Herbalife (HLF) only with the 18 and 40 simple MA lines back with the price chart. 

Notice that in February, MACD crossed down through the zero line at almost the exact same time that price broke its trendline.  This is the start of the change of trend sequence and the rally back in March sets up the classic sell signal following the 18 and 40 MA line crossover to the downside.  Zero line reversal signals take place when the MACD line itself rallies back toward that key level and turns down.  The is a great example because it shows the power of having confluence amongst the price structure (1-2-3 change in trend), the MA pattern (classic sell signal) and the failure of the MACD line near its zero level.  When you can build a case with independent signals, your odds will improve.

The daily chart of Delek US Holdings Inc. (DK) above shows the zero line reversal in a different form.  This rally toward zero signifies the counter trend rally on this time frame vs the downtrend on the higher time frame (weekly).  Notice the 1-2-3 sequence that takes place as well as the buy signal that fails using the 18 and 40 MA lines. MACD crossing down through its Signal line is the operative sell signal here and gives the investor a great timing tool to use in conjunction with the other indicators.  I cannot stress enough the skill of recognizing the price structure together with the MA setups to give you the understanding of where a stock is situated in its price trend.  Then, adding the MACD will improve the timing and confidence even more.

The chart of Sysco Corp. (SYY) is another example of a zero line reversal which helps with the timing of a lower time frame entry.  The red arrow points out the actual MACD cross of the Signal line following the zero line reversal. 

Using the MACD Indicator

Using the MACD Indicator

MACD stands for moving average convergence divergence.  This indicator has been one of the most popular indicators for the past few decades.  MACD is a momentum indicator and can be useful for determining the strength of a given trend, overbought and oversold conditions as well as imminent reversal areas.  In basic terms, MACD plots the difference between two moving average lines.  The creator of the indicator, Gerald Appel, used exponential moving averages in his calculation.  The popular EMA lines used are 12 (fast) and 26 (slow) and the difference between these lines is displayed as the actual MACD line.  In addition, this indicator employs a Signal line, which is a moving average of the MACD line, in this case a 9 EMA.

I have always used the original MACD settings in my work with clients over the past 30 years.  MACD was the first indicator I used when I started in technical analysis and has continued to play a role in my interpretations of the trend and its strength.  An important factor is that since MACD is based on MA lines, it is calculated using the closing price of a stock.  The high and low range for each bar is completely ignored.  This fact will become more significant when I explain the use of the ADX indicator in the future articles.

If you browse through the example charts in my book, you will notice MACD is in the lower scale on every one of the charts.  There are specific signals and characteristics I look for when using this indicator in conjunction with the 18 MA and 40 MA lines.  I am sure you are wondering how a 12/26 EMA indicator would work with 18/40 SMA lines.  Keep in mind, the idea is to use the methods independently and then look for common ground.  I purposely started with articles related to the price action and trend.  The reason, as I stated earlier, is that you must become proficient at reading price patterns, trends and structure without the use of indicators before moving on.  It is critical that you develop the skill of seeing the trend and change of trend, preferably with only price bars on the chart.  Then, it becomes useful to use indicators to improve and enhance what you are already seeing with the price action.  To repeat, start with price bars, then add MA lines, followed by using the MACD or ADX or both. 

There are specific patterns that develop with MACD that I am going to cover with numerous examples.  The four most prominent signals for my work are zero line reversals, pinch plays, momentum divergence and reverse divergence.

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