Friday, August 22, 2014

A Better Indicator than MACD: Leading vs. Lagging Indicators

By Martha Stokes, CMT

MACD is one of the most popular indicators for retail traders, particularly for traders with less than 2 years of market experience. This is primarily due to retail online brokers and trading systems which promote the use of MACD for retail trading.

However, the question that every trader should be asking is if MACD is such an awesome indicator, why do most retail traders lose money trading stocks?

Here is the answer:

While MACD was an excellent indicator when it was first written, there are several reasons why MACD is no longer the best indicator to use for short-term trading. This is especially true if you are a swing, momentum, or day trader.

  1. High Frequency Trading firms discovered a few years ago that retail traders use MACD, and that their brokers encourage them to use MACD for automated retail-trading systems. HFT Quants wrote algorithms to exploit and front-run retail traders using MACD systems. With so many retail traders all trading exactly the same way, using MACD as an entry signal, it creates anomalies in order flow called “cluster orders.” Cluster orders are easy for the algorithms to identify. The HFTs are able to jump ahead in the queues to buy ahead of the retail cluster orders, and then start selling as retail-trader orders move through.
  2. MACD is a lagging indicator due to the new order-processing systems, which are exclusively available to the Dark and Twilight Pools and other professional trading venues. The Dark Pools have controlled bracketed orders which do not move price, even while they buy huge quantities of stock. The trick is they buy in incrementally with controlled bracketed orders, which contain the price they are paying in a tight price pattern.
  3. Professional Traders are also aware of the retail crowd’s obsession with MACD. Pros have often developed their own, unique indicators and trading systems, and they can easily exploit the retail traders using MACD because it lags the price action.

In the chart above, a modern indicator called TT Volume Accumulation (TTVA) leads the price movement. It is able to lead price because it is comparing current VOLUME to prior volume overtime. By comparing large-lot activity versus small-lot activity, the TTVA indicator is able to determine whether the buying is on the upside tick or downside tick, differentiating where the Dark Pools are buying or selling. This is crucial, especially after a correction in the market, OR at a high, speculative-trending market at risk of a top.

The MACD indicator lags, as it is based on the very old and outdated moving averages, which inherently lag; so, price must move up first before MACD can give a signal.

TTVA, on the other hand, signals several days ahead of MACD, allowing the short-term swing, momentum, or day trader to buy in earlier, earning much-higher profits on the short-term horizon.

The significance of seeing the reversal pattern before price moves up is important. Each extra point adds up. If you are trading 100 shares, 1 extra point gained in a trade equates to an additional $100 in profit. If you are trading 1,000 shares, it becomes $1,000.

This is why professional traders earn far higher incomes from trading than retail traders do.

When you learn to use indicators that signal ahead of price moving up or down, your income from trading will exponentially increase.

Trade Wisely,

Martha Stokes CMT

Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor & Developer of TechniTrader Stock Market Courses

© 2014 Decisions Unlimited, Inc. DBA TechniTrader®. All rights reserved.

Disclaimer: All statements are the opinions of TechniTrader, its instructors and/or employees, and are not to be construed as anything more than an opinion. TechniTrader is not a broker or an investment advisor; it is strictly an educational service. There is risk in trading financial assets and derivatives. Due diligence is required for any investment. It should not be assumed that the methods or techniques presented cannot result in losses. Examples presented are for educational purposes only.

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