Asbbs 2014

MARKET TIMING WITH THE MACD

Reinhold LambUniversity of North Florida

Ibrahim AlfawzanSaudi Hollandi Capital

Richard ZuberUniversity of North Carolina at Charlotte

February 22, 2014American Society of Business and Behavioral Sciences

Predicting the Stock MarketEfficient Market Hypothesis (EMH)

Fama, E., 1965, “The Behavior of Stock Market Prices,” Journal of Business.

At any given time, prices fully reflect all available information on a particular stock and the market.

In efficient markets, prices become not predictable but random, so no investment pattern can be discerned.

Forms of EfficiencyStrong Form Efficiency

Semi-Strong Form Efficiency

Weak Form Efficiency - This type of EMH claims that all past prices of a stock or the market are reflected in today's prices. Consequently, technical analysis cannot be used to predict the market.

Moving Average Convergence-Divergence

“MACD” – Gerald Appel, 1977

An indicator of Momentum

Momentum - the tendency for rising prices to rise further, and falling prices to continue falling

Jegadeesh, N., and S. Titman, 1993, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48.

Jegadeesh, N., and S. Titman, 1999, “Profitability of Momentum Strategies: An Evaluation of Alternative Explanations,” NBER #7159.

Moving AveragesMoving Averages – smooth out fluctuations in the data to

identify trends

Simple Moving Average (SMA) = average of the prices in the series with equal weight for each closing price

Exponential Moving Average (EMA) = weighted average of the closing prices in the series with the most recent prices receiving more weight

MACD Construction

MACD Line (black)= 12-day EMA – 26-day EMA

Signal Line (red)= 9-day EMA of the MACD Line

MACD Histogram= MACD Line – Signal Line

Exponential Moving Averages

12 day• shorter moving average• “faster” - more reactive to price changes

26 day• longer moving average• “slower” – less reactive to price changes

9 day• Signal Line to identify turns in the trend

Convergence and DivergenceConvergence• moving averages move towards each other

Crossover• moving averages intersect and move from converging to

diverging or diverging to converging

Divergence• moving averages move away from each other

DivergenceDivergence• security price diverges from the MACD• signals the end of the current trend

Crossover Signal• MACD intersects with the signal line

• Bearish Signal – MACD falls below Signal Line• Bullish Signal – MACD rises above Signal Line 

MACD Signals: 2007-2012

MACD Decision RuleYes No

1. Prices and MACD make new highs then reverse X

2. Price and MACD decline X(MACD crosses below Signal Line)

3. Price trends up again to new high X

4. MACD trends up again but no new high X(MACD crosses above Signal Line)

5. Price and MACD both decline again X(MACD crosses below Signal Line)

PREDICTION: TREND OF LOWER PRICES BEGINS

Peak A Peak B Change PercentDate July 7, 2007 October 12, 2007Duration 12 weeksDJIA Value 13,851.08 14,093.08 242 1.75%

Peak B Trough Change PercentDate October 12, 2007 March 6, 2009Duration 73 weeksDJIA Value 14,093.08 6,469.95 -7,623.13 -54.09%

First Signal: October 12, 2007

Peak A Peak B Change PercentDate July 7, 2007 October 12, 2007Duration 12 weeksMACD Value 378.83 260.42 -118.41 -31.26%

1.Prices and MACD make new highs

New High

New High

2.Prices and MACD decline

Prices Decline

MACD crosses below Signal Line

3.Price reverses to new high

Reversal to new high

4. MACD reverses, no new high

MACD crosses above Signal Line but no new high

5. Price and MACD trend lower

MACD declines and crosses below Signal Line

Price declines

MACD Decision RuleYes No

1. Prices and MACD make new highs then reverse X

2. Price and MACD decline X(MACD crosses below Signal Line)

3. Price trends up again to new high X

4. MACD trends up again but no new high X(MACD crosses above Signal Line)

5. Price and MACD both decline again X(MACD crosses below Signal Line)

Prediction – Lower Prices Peak B Trough Change PercentDate October 12, 2007 March 6, 2009Duration 73 weeksDJIA Value 14,093.08 6,469.95 -7,623.13 -54.09%

Second Signal: April 30, 2010 Peak A Peak B Change PercentDate January 22, 2010 April 30, 2010Duration 14 weeksDJIA Value 10,172.92 11,008.61 835.69 8.21%

Peak B Trough Change PercentDate April 30, 2010 July 2, 2010Duration 9 weeksDJIA Value 11,008.61 9,614.32 -1,394.29 -12.67%

Peak A Peak B Change PercentDate January 22, 2010 April 30, 2010Duration 14 weeksMACD Value 357.39 326.99 -30.4 -8.51%

Third Signal: May 6, 2011

Peak A Peak B Change PercentDate February 18, 2011 May 6, 2011Duration 11 weeksDJIA Value 12,391.30 12,638.74 247.44 2.00%

Peak B Trough Change PercentDate May 6, 2011 October 7, 2011Duration 22 weeksDJIA Value 12,638.74 10,404.49 -2,234.25 - 17.68%

Peak A Peak B Change PercentDate February 18, 2011 May 6, 2011 Duration 11 weeksMACD Value 399.02 370.39 -28.63 -7.18%

Fourth Signal: October 5, 2012 Peak A Peak B Change PercentDate May 4, 2012 October 5, 2012Duration 22 weeksDJIA Value 13,038.27 13,610.15 571.88 4.39%

Peak B Trough Change PercentDate October 5, 2012 November 16, 2012Duration 6 weeksDJIA Value 13,610.15 12,471.49 -1,138.66 - 8.37%

Peak A Peak B Change PercentDate May 4, 2012 October 5, 2012Duration 22 weeksMACD Value 281.70 232.15 -49.55 -17.59%

Signal Performance Summary

Divergence Signal Decline

Signal DJIA Change DJIA % MACD Change MACD % DJIA Change DJIA % Weeks

12-Oct-07 242.00 1.75% -118.41 -31.26% -7,623.13 -54.09% 73

30-Apr-10 835.16 8.21% -30.40 -8.51% -1,394.29 -12.17% 9

6-May-11 247.44 2.00% -28.63 -7.18% -2,234.25 -17.68% 22

5-Oct-12 571.88 4.39% -49.55 -17.59% -1,138.66 -8.37% 6

-12,390.33 -92.31%