Quote from ScottD:
Moving Average Convergence / Divergence (MACD)
Introduction
MACD uses moving averages to create a momentum oscillator. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits.
Formula
The formula for the MACD is the difference between a security's fast and slow Exponential Moving Averages (EMAs). The most popular lengths for the EMAs is 12 for the fast and 26 for the slow. Closing prices are used to form the moving averages. For the ES, Jack has tuned these EMAs to 5 and 13, respectively.
Usually, a 9-period EMA of the MACD itself is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above the (typically 9-period) EMA of itself, and a bearish crossover occurs when MACD moves below. For the ES, Jack has tuned the trigger EMA to a length of 6.
The histogram is positive when MACD is above the (typicaly 9-period) EMA of itself and negative when MACD is below.
Code
For an automated trading system, the MACD Indicator is coded as follows:
inputs: FastLength( 5 ), SlowLength( 13 ), MACDLength( 6 ) ;
variables: var0( 0 ), var1( 0 ), var2( 0 ) ;
var0 = MACD( Close, FastLength, SlowLength ) ;
var1 = XAverage( var0, MACDLength ) ;
var2 = var0 - var1 ;
Plot1( var0, "MACD" ) ;
Plot2( var1, "MACDAvg" ) ;
Plot3( var2, "MACDDiff" ) ;
Plot4( 0, "ZeroLine" ) ;
condition1 = var2 crosses over 0 ;
if condition1 then
Alert( "Bullish alert" )
else
begin
condition1 = var2 crosses under 0 ;
if condition1 then
Alert( "Bearish alert" ) ;
end;
This MACD Indicator calls a MACD Function, which is coded as follows:
inputs: PriceValue( numericseries ), FastLen(numericsimple ), SlowLen( numericsimple ) ;
MACD = XAverage( PriceValue, FastLen ) - XAverage( PriceValue, SlowLen ) ;
The MACD Function calls an XAverage (exponential average) Function which is coded as follows:
inputs: PriceValue( numericseries ), Len(numericsimple ) ;
variables: var0( 2 / ( Len + 1 ) ) ;
if CurrentBar = 1 then
XAverage = PriceValue
else
XAverage = XAverage[1] + var0 * ( PriceValue - XAverage[1] ) ;
As you see here we are dealing with moving averages and for various reasons Scott has chosen the exponential type of moving average. There are some initial signals he built into the coding.
The originator had a specific way to do things and a specific application. He used absolute values for coding when a long or short signal occured. This is all pleasant history from that era. Most of the early work on applying arithematic to markets was at the beginning of the last century. Exponential thinking happened as time passed after the initial work.
In the demo solution I offered I didn't have the scaling because it would have given too many clues for the demo. I envisioned the demo as a quick give away of a cash cow for the ES that would be posted on Collective 2 where a site was paid for but not bearing fruit. Instead, Scott gave me a cool runfor the money which I thoroughly enjoyed and missed that the market was the debt market with shorter hours. Good for Scott. And I admit I am aging just a little here and there. LOL
We are going to use the MACD according to it's MODE primarily.
Tuning the MACD is an important matter and it works really well because of its behavior. What I will unfold here is not the usual. I will go back in time and give you the flavor of making money in an era of long ago. BUT there are important things about it that have not been kept in the picture.
We do not built log cabins anymore or wooden boats. Different tools are used today simply because they became available. But there are some underlying principles of market operation that have always reamined part of how markets operate.
This cash cow uses the market's operation as the basis and we just get signals from the market by being vey skillful in using our indicator set.
MACD has several subsets of operating characteristics. we will add the coding to get the signals of these and retire the usual signals that are now showing in the coding.
Before we retire these two lets look them over.
One line on the graph is a difference of two EMA's. It is chosen to be tuned to the market PRICE ACTION. It is like all canoes and and Olympic Kayaks are tuned to the curl, divergence and gradient of the race course. The slither factor is important, so to speak. "Go with the flow" is a common expression.
We all see waves in price movement. They flow up hill, down hill and across on the flats. "tuning makes sure that our kayak does sit on the tops of several peaks (at least two). This is "bridging" PA if we do. The Ross Hook is a bridging signal for example. The 3BR is like walking along side the river mile after mile looking for a haystack after a rapids.
we set up our difference of EMA's as an Olypic Kayak that can slither and not bridge waves or haystacks. We want all the PA we can get. So we have those as indicasted by Scott.
We pick another EMA of the difference of the two; it is "in between" in duration, i. e., 6 is in between 5 and 13.
No bridging great slither tunning and now we can see price reflected in an indicator. MACD lags the forming price and volume bar.
This is "insurance" lagging indicators provide powerful constructive insurance for our objectives" making money in profit segments one after another.
We did see already that the signals chosen for doing segments have a neat characteristic. the exit of one tade happens around the time of the beginning of the next trade. Actually the exit is a little after the next entry most of the time.
This creates a slice that is narrow and powerful for elocidating what Jem calls the "moment of a good trade" that comes and goes fairly rapidly. Doing bad trades involves all kinds of avaialble time. Doing good trades involves only short periods of excellent time. Look at all the bad time in 1,2, 3, trading (This is NOT a REFERENCE to pts 1, 2, and 3 of the three levels of SCT trading). LOL.
The slice between an new entry and the end exit of a prior hold is brief. See points F (entry) and G (exit) of yesterday's annotated ES chart.
This is where we will take CW traders out of their Lizard Freeze Up and single point freakout trading syndromes.
But we have to code thee indicators for their signals first. Then we have to integrate the signals form these using what in programming is called logic.
There is a nuance in logic for programming. as tough as it sounds, logic cannot be constructed using induction. The null hypothesis must be used.
As an additional correlated comment, inductive backtesting turns out to be trying to prove something doesn't work. In logic it is not possible to prove something doesn't work. That is not the subject ofbuilding cash cows, however.
MACD's have three fruitful indicator signal arenas. We will use each and every one. One is the CD operation and another is the "entwine" function and the third is the money velocity arena.
We never get trading signals from MACD. MACD is for slithering properly. Making bacon is what MACD keeps us doing.
I will take up each arena in turn since we have to build code for each.
