Very often a trader starts out with a simple idea for a trading method. Then he starts to add more bells and whistles to that simple idea. Eventually he winds up with something that in no way resembles his original idea, and starts stripping things away until he gets back to something simple enough to actually work in the real world. Believe me. I am well versed in this process.

I have always been a systems guy. Well, okay, not always. I should say that I have always been a systems guy since I finally realized that I wasn’t a very good discretionary guy. While I don’t think anyone would describe me as overly “emotional,” when there is money on the line, let’s just say I got the “fast twitch” gene. Still, as the years have gone by I find myself accumulating a number of “non-systematic” tools. The key here is that these tools may or may not be used to systematically signal trade entries and exits so much as they are useful in identifying potential opportunities. In other words, instead of saying “buy now” or “sell now,” these tools simply say, “hey, look over here.” The tool I want to mention today can be referred to as “The Sneaky MACD.”

MACD is an indicator known to most technical traders, which was developed by Gerald Appel. MACD is short for “moving average convergence/divergence” (do not attempt to say that three times quickly). This versatile indicator has many uses -   longer-term, shorter-term, trend-following, overbought/oversold. You name it, someone is using it that way. The pattern that I want to highlight involves MACD “sneaking” higher while price action remains somewhat dormant. Consider Chart 1.

AAPL makes a top in November, then spends four months consolidating before running up to retest the previous high. Will the test end in a successful breakout?  For a clue, take a look at the MACD indicator in the lower clip. Towards the end of March and even as AAPL price action continued to consolidate, MACD reasserted itself to the upside.

Chart 1 – AAPL Setting Up

So does this story have a happy ending? Take a look at Chart 2. As you can see, in this case AAPL broke out to the upside and shot higher in the weeks ahead.

Chart 2 – AAPL Breaks Out

Let’s consider another example. In Chart 3 we see INTC price action forming a tight narrow trading range. A trader looking only at price action has no real way to gauge what will happen next. At the same time, however, in the lower clip you can see MACD rising steadily off of its low. Sneaky, eh?

Chart 3 – INTC Setting Up

So does this setup constitute a clear-cut “mortgage the house and put it all into Intel” buy signal? Not at all. It does, however, alert us to the fact that there may be a low risk opportunity at hand. For example, a trader could buy INTC at 19.31 (or he could buy a call option) and place a stop below the recent low of 18.86 so that if the trade does not work out, the loss experienced would be very small.

As you can see in Chart 4, INTC broke out to the upside and experienced a nice sharp run in a matter of weeks. The buyer of a call option could have potentially doubled his money in this simple scenario.

Chart 4 – INTC Breaks Out

This simple setup can also be used to identify opportunities in the futures markets as well. Chart 5 displays July 2007 soybean price consolidating after a recent decline. In the lower clip we once again see MACD “sneaking” higher.

Chart 5 – Soybeans and MACD Setting Up

The combination of the two factors is what is important: prices indeterminate, MACD clearly edging higher. In Chart 6, we once again see price breaking out strongly to the upside and rallying sharply for the next several weeks.

Chart 6 – Soybeans Breakout to the Upside

Summary

So does every simple “price consolidation/rising MACD setup” work out profitably all the time? I think we all know the answer to that question. But please remember that the “Sneaky MACD” tool is not presented nor intended to be a “be all, end all” comprehensive approach to trading. It is simply a filter that any trader can use to alert them to potential opportunities for low-risk, high-reward trades. Short-term traders especially may do well to consider adding this simple “hit-and-run” tool to their trading arsenal.

To search for previous articles written by Jay Kaeppel, please click here.

Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

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