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The moving average convergence-divergence (or MACD, as it is familiarly known), one of the more popular technical indicators, was invented by technician Gerald Appel to trade the 26-week and 13-week cycles of the stock market. Commodity traders often use daily data with MACD but still use 26-period and 13-period exponential moving averages (EMA) in the analysis. The implication is that there are 26- and 13-day cycles in commodity markets. Beliefs such as this (for example, that only a 14-day relative strength index is correct) incite my curiosity enough to make me do some research. The basic premise by which I work is that the market is always changing and your trading strategy and indicator parameters must change to fit the current market conditions. Specifically, I have studied the Standard & Poor's 500 and have found an unusual combination of MACD parameters that produces good profits a surprisingly high percentage of the time. This unique use of the MACD indicator can be applied to almost any market at one time or another.

THE TRADITIONAL MACD

A 26-day EMA is the first moving average and a 13-day EMA is the second moving average in a traditional MACD. The MACD line is formed by subtracting the long (first) moving average from the short (second) moving average. A signal line is formed by smoothing the MACD line with a third EMA. The third moving average is usually a 10-day EMA. For the sake of simplicity, causing only a small amount of distortion, I use the third EMA to be equal in length to the second EMA.

I studied the Standard & Poor's 500 and found an unusual combination of MACD parameters that produces good profits a surprisingly high percentage of the time.

The classic MACD of the Standard & Poor's 500 index shown in Figure 1 is for about the first four months of 1991. MACD and its signal are shown below the bar chart. The signal is the smoother of the two lines. It's clear that MACD goes up when prices rise and MACD goes down when prices fall. Some time lag exists between the peak of the prices and the peak of the MACD; buy/sell signals are formed when the MACD crosses its signal and are indicated by the up and down arrows at the bottom of the bar chart. Used in this way, the MACD nicely caught the uptrend in the January/February time frame.

MACD can also be used as an overbought/oversold indicator. Successive highest highs (or lowest lows) of price are compared with successive highest highs (or lowest lows) of MACD. In Figure 1 the successive highest highs of price trend up in the February-April time frame while the successive highest highs of MACD trend down. This is a divergence. This divergence is often interpreted as an overbought condition.