Today, you’ll learn how to avoid MACD false signals.
As a general rule, to avoid MACD false signals, traders can use a momentum indicator, watch the time and sales window, and look for a bounce on a powerful support.
Momentum indicators can confirm and verify MACD signals which help traders make an excellent trading decisions.
After verifying the speed of the price move of a stock, traders may observe the amount of trades on the time and sales window when MACD generates buy and sell signals.
Observing time and sales window can help in predicting the next price move of a stock.
- What is MACD?
- Use a momentum indicator
- Watch the time and sales window for signs of momentum
- Look for a bounce on a strong support
What is an MACD indicator?
According to Fidelity, MACD is a momentum indicator used for trading trends. (source)
Although it is an oscillator, traders usually use the indicator for trading securities with an obvious trend.
Of course it can also be a good indicator in consolidating markets, however, this type of trading environment is too risky.
The present risk that exist are usually the range expanding and contraction.
Range expansion can take out a lot of stops because it is a system design to take out beginner traders.
The market range contraction usually profit from impatient traders.
Overall, the market is a place for market makers to make money.
Three types of MACD Signals
The three types of MACD signals are the oversold, overbought and the cross of the zero line signals.
Oversold is a signal that the stock is about to go up while an overbought signal shows weakness.
The third signal may detect the momentum of the stock.
A bullish momentum is present if the signal line crosses the zero line from below.
Also, bearish signal is the current sentiment if the signal line crosses the zero line from above.
However, in this post, the zero line is not a topic that we will discuss below considering that it is a lagging indicator.
It is lagging because most price actions are not helpful to traders anymore.
The zero line of MACD can also be a profit taking areas for those who bought the stock from below.
Use a momentum indicator
There are two indicators for avoiding false signals from MACD.
- ALMA indicator
The RSI indicator is a suitable match for MACD indicator. Well, the combination of both is popular among short-term traders.
Short-term traders often use the RSI value of 50 and 30 to understand the current market price action.
If the RSI value is above 50, the trend is usually up while the value below 30 is bearish.
When the value of RSI is between 30 and 50, the market is in a consolidation state.
How can traders use both the indicator?
Well, when there is a bullish cross signal from MACD, traders can verify if the RSI is above 50 before considering buy trades.
For exits or short trades considerations, traders may sell or short a stock when MACD has a bearish signal and RSI is below 30.
Alma Indicator (Arnaud Legoux Moving Average)
The ALMA indicator is an advanced trading indicator, which is significantly faster than the traditional Simple Moving Average.
When the price breaks the ALMA from below, the type of the signal is bullish.
Traders can use this signal for verifying a bullish cross in MACD.
For example, an oversold signal from MACD is a good signal when the price breaks above the ALMA indicator.
The exit is usually at the breakdown of the price on the ALMA indicator.
Watch the Time and Sales Window for signs of momentum
The time and sales window is an excellent tool to understand the price action of the market.
When the price breaks the ALMA indicator, after a bullish cross from MACD, traders can observe the time and sales window.
The breakout will continue when there is high buying volume.
Continuation often happens when there are fast buying.
Fast buying means the last trades are moving fast, which is above normal buying activities.
Because the traders are adding more to their shares, there is a high probability of avoiding MACD false signal.
If instead the market is slow or there are no active buyers, it is important to avoid the MACD signal.
When traders take slow markets, they will probably lose money because there is not enough volume and activity.
Unless, they are in the trade for the long-term which has also no guarantee to make profits.
However, for short-term traders, volume and trade activity is essential.
Trading activity must be high for a trading signal from MACD as valid or high probable.
There should be more traders trading the stock.
If few traders are there in the market, MACD signals are useless considering that there is no trading interest.
Look for a bounce on a strong-support level
Before buying a security, considering there is a MACD signal, find an excellent support level.
If traders buy after the up move is already underway, it is usually too late.
Unless the bounce or pull back is a signal used for verifying the momentum within the MACD bullish signal.
For example, when there is a bullish oversold cross of MACD and then a breakout of ALMA indicator, there is usually a confirmed bounce from the strong support line.
It is often a way to avoid MACD false signals.
When there is no breakout on the ALMA indicator, it is better to avoid the trade.
Avoiding low probability set-ups helps traders reduce their losses and improve their trading.
However, every high probability trade is not a guarantee or holy grail.
It may help traders improve the outcome of their short-term trades.
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