Technical analysis is an integral part of mastering covered call writing. This week’s article is a follow-up to an article posted on October 19th. In this week’s column I will discuss the MACD histogram which represents the difference between the MACD indicator and its trigger, the 9-d EMA (exponential moving average). It is plotted in the form of a histogram (bar graph) rendering divergences and centerline crossovers 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 (taller bars) 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 (bars are longer under the zero line) 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 (black line @ top of chart) vs. MACD Histogram (blue bars @ top of chart)
Bullish signals are highlighted by the blue arrows where the histogram bars move above zero and the price of the stock then rises Bottom half of chart). 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.
Current example from our Premium Stock report:
- Red circle: Positive and ascending bullish MACD Histogram
- Green circle: Strong volume confirmation of bullish technical signals
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.
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.
Next live seminar:
International Trader’s Expo
Friday, November 22nd
10:45 – 11:45 AM
The market reacted favorably to the Federal Reserve’s chief candidate Janet Yellen comments supporting the Fed’s recovery efforts. That aside, it was a light week for economic reports:
- Janet Yellen’s comments that the unemployment rate of 7.3% was still too high hinting that a December pullback was unlikely
- Industrial production was down 0.1% in October disappointing expectations of a 0.2% gain. This was mainly the result of decreases in mining and utility production. However, for the previous 12-month period, industrial production rose by 3.2%
- According to the US Department of Labor 3rd quarter 2013 nonfarm production (a measure of the growth of labor efficiency in producing the economy’s goods and services. It is considered an indicator of future inflationary trends) rose by 1.9%
- The trade deficit was up nearly 8% in September, the highest level since May
- Manufacturing was up 0.3% in September, increasing for the 3rd consecutive month
For the week, the S&P 500 was up 1.6% for a year-to-date return of 28.5%, including dividends.
IBD: Confirmed uptrend
BCI: Moderately bullish, favoring out-of-the-money strikes 2-to-1
My best to all,