This week’s article is a follow-up to last week’s discussion of the MACD technical indicator. In this week’s column I will discuss the MACD histogram which represents the difference between the MACD and its trigger, the 9-d EMA. It is plotted in the form of a histogram (bar graph) rendering divergences and centerline crossover easily identified.
Bullish histogram signals:
- A centerline crossover (i.e. the histogram bars move above the centerline) into positive territory. This is equivalent to the MACD moving average crossover signal, in which the MACD moves above (for a bullish signal) or below (for a bearish signal) its trigger line.
- Increases in the positive histogram show strengthening momentum.
- Positive divergence of the histogram will usually precede a positive move of the MACD itself.
Bearish Histogram Signals
- A centerline crossover (i.e. the histogram bars move below the centerline) into negative territory. This is equivalent to the MACD moving average crossover signal, in which the MACD moves below (for a bearish signal) its trigger line.
- Increases in the negative histogram show strengthening momentum in a negative direction.
- Negative divergence of the histogram will usually precede a negative move of the MACD itself thereby giving us an earlier warning signal of a potential price decline.
The chart below depicts both bullish and bearish MACD Histogram signals:
MACD vs. MACD Histogram
Bullish signals are highlighted by the blue arrows where the histogram bars move above zero and the price of the stock then rises. Bearish signals are noted by the red arrows where the bars drop below zero and the price of the equity then declines. It is important to note that these histogram signals occur before the MACD itself (black line) moves above or below zero. This is why I prefer the histogram…it is a quicker indicator of change.
How to use the MACD Histogram:
A widening gap between the MACD and its trigger line (also known as the histogram which is the difference between the MACD and its trigger) shows strengthening momentum, while a shrinking gap will demonstrate weakening momentum. A bullish signal occurs when there is positive divergence or a widening gap between the two and a bullish centerline crossover. A bearish signal exists when there is negative divergence (closing gap between the two) and a bearish centerline crossover. Notice in the above chart how the histogram provides a bearish signal before the MACD (January, 2010 for example)) and a bullish signal prior to the MACD (March, 2010 for example). Specifically, the histogram crosses the zero line before the MACD itself. Therefore it can be said that the MACD and the MACD Histogram are independent of each other.
Advantages of the MACD Histogram:
- Divergences are apparent before MACD moving average crossovers.
- Can be used to signal impending reversals.
- Easy to read and quick to interpret.
Conclusion:
MACD and the MACD Histogram are two of the more reliable technical analysis tools available to us. They incorporate both trend-following and momentum identifying qualities and are predictive in nature. As with other technical tools, they should be used in conjunction with other indicators to assist in painting a picture for potential buy/sell decisions.
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Complete Encyclopedia for CC Writing
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Market tone:
We experienced another week of mixed economic reports:
- The Fed plans to move $400B from short-term to long-term Treasuries in an effort to keep long-term borrowing costs low to enhance spending and investment
- The Fed reported that inflation has slowed
- The Leading Economic Indicators rose by 0.3% in August, the 4th straight increase and better than analyst expectations
- New residential construction dropped by 5% in August mostly weather-related
- Sales of existing homes rose by 7.7% in August, above expectations
For the week, the S&P 500 fell by 6.5% for a year-to-date return of (-) 8.3%, including dividends. We are currently 1 week into a 5-week October contract so there is still time for recovery prior to expiration.
Since August, the stock market has dropped precipitously and this past week the panic continued. We witnessed major bank downgrades, fears of a Greek default and negative comments by the FOMC (Federal Open Market Committee). This resulted in a selling spree of commodities (including gold) and stocks. So the question is: is there a silver lining or is it all doom and gloom. Although it is impossible to predict the markets precisely, I am going to remain a bull at this time. As you know the Fed has been keeping interest rates at an all-time low. Listen to these Treasury yields:
- 3-month bill: 0%
- 6-month bill: 0.3%
- 1-year note: 0.1%
- 2-year note: 0.2%
- 3-year note: 0.34%
- 5-year bond: 0.79%
I’m falling asleep just typing this! The main point I see in this is that the S&P 500 dividend yield is significantly more than these treasury yields, currently @ 2.15%. Doesn’t it make sense that institutional investors will return to stocks rather than languish in the low rates of these bond yields? Another short-term factor could be “window dressing”. This is where corporations buy back their stock at the end of a quarter to boost earnings per share prior to the 3rd quarter earnings announcements. This could result in a boost to the market next week. Let’s take a look at a 6-month bar chart of the S&P 500:
6-month chart of the S&P 500 as of 9-23-11
The red arrow to the left shows the last time the market had a steep decline and the green arrow shows a quick recovery. This occurred in late June prior to the end of the 2nd quarter. Since then the market has declined substantially as alluded to above ( red arrow to the right) and is now in a trading range (yellow area). It will be interesting to see if the corporations step in next week to buy back shares and make their bottom lines look sexier for the 3rd quarter.
Summary:
IBD: Market in correction.
BCI: This site remains cautiously bullish favoring in-the-money strikes.
Wishing you the best in investing,
On the premium reports is the MACD information in the “comments” column referring to the histogram only?
Thanks for your help.
Lori
BCI Community,
As you may know, the BCI methodology is momentum based. This morning, on the Larry Kudlow radio show, he had Doug Kass as a guest commentator. Mr. Kass is a commentator on CNBC (yes I know that we try to avoid the “talking heads” on TV), but he has a great track record in his market calls.
A caller asked about “momentum” based trading vs. fundamental based trading. He responded that the best tool for “momentum” traders is IBD. As you know, IBD and the IBD50 (along with other stocks) is one of the foundations of the BCI system. I thought this was a great validation of our approach.
Just my own view…but I wanted to share the comment with all of you.
Best,
Barry
Alan,
Will your new book be available in kindle?
Premium Members,
The Weekly Report has been uploaded to the Premium Member website.
Best,
Barry and the BCI Team
Lori (#1),
Yes. Since the histogram gives us a quicker indicator of a price or trend change and because most of us are selling 1-month calls, we focus on the histgram in our weekly reports.
Alan
Fran (#3),
My new book will be available in both hard and soft cover and in kindle format shortly after release of these versions.
Alan
Alan,
Are the stocks on your watch list with mixed technical signals eligible for trading or should we wait for all signals to be bullish?
Tim
Alan,
You mention delta in your article on increasing dividend yield with LEAPS. Where is the best place to locate delta information.
Thanks as always.
Fran
Tim (#7),
Yes. These stocks pass all the BCI fundamental screens but have mixed technicals which may motivate conservative investors to opt for stronger stocks or sell in-the-money strikes for the additional downside protection. The stocks in bold passed all screens with ALL confirming technicals. Because of last week’s market decline only one stock was in bold in this week’s report so there are about 20 equities on the running list with mixed technicals.
Alan
Fran (#8),
Here is a link to a CBOE calculator that provides info on the “Greeks”, including delta:
http://www.cboe.com/framed/IVolframed.aspx?content=http%3a%2f%2fcboe.ivolatility.com%2fcalc%2findex.j%3fcontract%3dC7A2763B-1902-45A5-ADAB-ECE97EDEAE40§ionName=SEC_TRADING_TOOLS&title=CBOE%20-%20IVolatility%20Services
Alan
European debt crisis:
This Thursday, September 29, the German Parliament will vote on the European Financial Stability Facility, the rules and conditions Germany will impose for further debt support for European countries. Since the budget committee approved the government’s bill last Wednesday and most opposition parties have indicated they intend to vote with the government the vote should pass. Although this is not likely to be the end to the European sovereign debt problem, perhaps it will be enough for the equity markets to find some support and stabilize.
Alan
In your experience how often are options exercised prior to the dividend pay date?
Thank you
Tony
Interview published:
Another interview I did a few weeks ago was just published on the Business Info Guide website:
http://businessinfoguide.com/interview-alan-ellman-author-of-cashing-in-on-covered-calls/
Alan
Tony,
If the option holder wants to exercise the option to capture the dividend it will happen prior to the ex-dividend date (usually the day before). If the dividend is greater than the time value of the premium chances of early exercise increases. You can also look at the delta of the option…the closer to “1″, the greater the chance of early exercise.
Alan
Premium members:
An updated list of high dividend yield stocks with LEAPS has been uploaded to your premium site. Look in the “resources/downloads” area for the report titled “High Dividend Stocks with LEAPS October-November”. There are several new entries on this file.
For your convenience, here is the link to login to the premium site:
http://www.thebluecollarinvestor.com/member/login.php
Not a premium member:
http://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
Alan,
Do you ever roll up in the same contract month if the stock price increases well past the strike price?
Thanks .
Tim
Alan,
I just ordered your books and can’t wait to read them. I have been following your blog for the past two months. I am totally confused about one thing. What aren’t all options exercised if the strike price is lower than the current stock price? As an example, let’s say the option buyer has a 35 option and the stock price is 40?
Thanks a lot.
Jerry
Tim (#16),
I will RARELY roll up in the same contract cycle. We are dealing with situations where a stock price has risen substantially in a short period of time. If you calculate as follows:
Share appreciation as a result of raising the strike minus the option debit = ?
In most cases the return is in the area of 1% and now we have to hope that profit-taking doesn’t kick in after the rapid rise in price. I would consider this only in raging bull markets.
What I would prefer to do is:
1- Take no action as my goals where achieved and I have signifcant protection of that goal. Or
2- Unwind my total position when the time value of the option premium approaches zero (mid-contract unwind exit strategy).
Good question…it comes up all the time in my seminars.
Alan
Alan,
I recently subscribed and received your email about the high dividend yield stocks with leaps list. Can you explain how we use this as I didn’t see it in your books.
Thanks for a great site.
Nancy
Followup to comment # 11:
The German Parliament has voted to APPROVE Europe’s bailout fund, a positive for our stock markets.
Alan
Jerry (#17),
The answer lies in the “time value” of the option premium. An option premium consists of intrinsic value (amount in-the-money) + time value (impacted mainly by time left until expiration and volatility of the underlying stock). In your example, there is $5 of intrinsic value. The option premium will be $5 + time value, let’s make up a number and say $1, for a total of $6. The option holder can exercise the option and buy the stock @ $35 and sell it at market for $40 for a $5 profit. But he can also just sell the option for $6, obviously the better choice. Most options will not be exercised until the Saturday after expiration Friday when options are settled.
Alan
Nancy (# 19),
Glad you like the site. This is a strategy I developed after publication of my first two books. It will be included in my upcoming third book. Here is a link to a video I produced that describes this strategy and the stocks on the list are great candidates to choose from:
http://www.youtube.com/watch?v=b0770ZENMqI
Alan
A question about the high dividend stock report. The RS means relative price strength but relative strength to what? I can’t find any info about that criteria.
Thanks for any guidance.
Bill
Bill,
Relative to other stocks listed on the major exchanges. The price % change is calculated and ranked 1 through 99 with 99 being the best. A stock with an RS rating of 73 has had a greater 6-month price performance than 73% of the stock database. Because we are screening for stocks that have both high dividend yield and LEAPS we need to have a lower RS requirement (than traditional covered call writing) in order to have a palatable list size.
Alan
VFC:
Reported an outstanding 2nd quarter earnings report on July 21st. This was the 7th consecutive earnings surprise as earnings increased by 17% over the same quarter last year. Revenues rose 15%, the 5th consecutive quarter of increasing revenues. Operating income also increased by 11% year-to-year. Management raised earnings and revenue guidance and gave bullish projections for the 2nd half of 2011. Valuation remains reasonable @ 14.7 x forward earnings. Check to see if this equity deserves a spot on your watch list.
Alan
Hypothetical – I write a covered call and it isn’t purchased. What happens after the expiration date? Does the call disappear? Do I have to do something with the brokerage account or is it automatic?
Christian,
If the option is not exercised and your shares are not sold, the option expires. You keep the premium and still own the shares. You are now free to write another option for the next contract period. No action needs to be taken on your part.
Alan