Moving Average Convergence/Divergence (MACD Indicator) 2: Avoiding false MACD signals with the ChartMill Trend Indicator

Introduction

In our first article you could read exactly what the MACD indicator does and how you can use it as a momentum indicator. However, we also indicated that by no means all buying or selling signals are equally successful!

Fortunately, there is a simple way to detect these false signals to a large extent in advance and thus also to avoid them.

True/False…

Looking back at the graph of the previous article it is quiet obvious that – just like any other technical indicator – the MACD is not a ‘Holy Grail’ indicator either. What’s more, by relying solely on the pure buying and selling signals of the MACD, you’ll eventually lose money, not only because the indicator itself is not reliable enough, but also because you’ll be doing mass trades with all the associated costs…

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The red dots on the price chart show the sell signals of the MACD indicator, despite the fact that the price continues to rise. As a trader you prefer to ignore them, unfortunately you don’t know in advance whether such a signal will be false or successful….

That does not mean, however, that the MACD indicator is completely useless; we simply need to find a way of ensuring that we can avoid a large proportion of the false signals beforehand.  In this article we use the ChartMill Trend Indicator for this purpose.

The ChartMill Trend Indicator as an extra filter

The ChartMill Trend Indicator is an exponential moving average line that roughly represents the trend of the share. You can display it as an overlay on a chart or as a bar indicator underneath the chart. If the indicator is green, the price rises, the line is red when the price falls and grey means that the price zone is neutral.

AWI_chart

More information about the ChartMill Trend Indicator can be found in this article.

Remember, in particular, that the ChartMill Trend Indicator reflects the current trend of a price chart. When applied to the first graph of the VISA share in this article, we get the following chart:

V_chart

As you can see on the graph above, we are clearly facing an upward trend as far as the VISA company is concerned.

Because the ChartMill Trend Indicator clearly shows the existing trend, we can use it as an extra filter for our MACD indicator. As a rule, we will ignore all MACD sales signals if the ChartMill Trend indicator is green! If we apply that rule to the first graph of this article we get this :

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Indeed, by applying the ChartMill Trend Indicator in this case (which by its green color indicates that the trend of the stock is increasing) we manage to avoid all the false sell signals of the MACD.

The same method can of course also be applied if the trend of the stock is clearly decreasing (ChartMill Trend Indicator is red) and the MACD indicator generates buy signals.

Conclusion

As with all other technical indicators, as far as the MACD indicator is concerned, you can never simply use all the signals as buy and sell triggers. There are simply too many (false) signals. An additional indicator that indicates in which trend the stock is and then uses this information in combination with the MACD signal ensures that already a lot of false signals are filtered out.

ChartMill

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If you want to use Chartmill more intensively why not choosing an annual subscription? It costs less than $ 22 per month. This allows you to use our stockscreener completely unlimited, including all future updates!