Thursday, March 25, 2010

Trixy divergence

Many stock jocks are at least passingly familiar with the MACD indicator. MACD is the acronym for Moving Average Convergence/Divergence.

It's essentially a momentum indicator. It takes two moving averages of an index, a longer one and a shorter one, and combines the net difference. Thus, because shorter term averages more closely follow daily movements, as the shorter one rises faster, say, than the longer average, the MACD shows positive movement. The stronger that correlation, the stronger the positive reading on the MACD.

It is trend following, obviously because it is a moving average indicator, but it also suggests the strength of a move. It's all a bit more complicated than that, as you can see here.

But it is not only the movement of the 2 averages against each other, but the movement of both of them against the index that provides implication for index strength or weakness. As prices rise when the MACD is falling, it suggests a weakening of buying strength, and vice versa.

The StockCharts link above includes several textbook charts on the predictive (or, more accurately, betting) value of that divergence.

Now, the MACD uses exponential moving averages to highlight the influence of recent movements, although it can be adapted to longer averages to smooth events. In a bigger picture, it may prove useful to take that a step further and smooth the MACD with triple exponential values, which is what the TRIX does. The TRIX is an exponentially smoothed MACD, basically.

The TRIX is not so much a trader's tool than an investor's, trying to capture, as it does, the bigger picture. As StockCharts describes it, "TRIX is designed to filter out stock movements that are insignificant to the larger trend of the stock".

Guambat, being the slothfully slow creature that he is, keeps a sloe eye on the TRIX.

This is what it looks like in the S&P index context at the moment:

Click on these charts for a larger version (right click and open in new tab to keep this place handy).

And to put that in a larger context, this is what the major indexes (Dow, Nasdaq, S&P, FTSE, Germany, France, Japan and HK) look like:

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