Wednesday, May 24, 2023
- Momentum picked up steam for the S&P 500 last week until overhead resistance came into play at 4,200. Stocks have once again struggled to surpass this hurdle, although it shouldn’t be too surprising given the ongoing debt ceiling drama in Washington.
- While last week’s rally wasn’t enough to clear resistance, it was enough to flip the Moving Average Convergence Divergence (MACD) indicator back into a buy position.
- What is the MACD? MACD combines momentum and trend following into a single indicator and, as the name implies, is based on convergences and divergences between a long- and short-term exponential moving average (EMA).
- How does it perform? Historically, MACD buy signals have generated above-average returns, with a relatively high frequency of positive returns occurring across most timeframes over the following year. Returns tend to improve when buy signals occur when the S&P 500 is trading above its 200-day moving average (dma)—as was the case last week.
- Sell signals on the MACD indicator are not as ominous as they sound, as they tend to produce below-average, but still positive, returns when the S&P 500 is trading below its 200-dma.
What is MACD?
This popular technical tool was first introduced by Gerald Appel in 1979 and combines momentum and trend following into a single indicator. As the name implies, the framework of the indicator is based on convergences and divergences between a long- and short-term exponential moving average (EMA)—often a 26-week and 12-week EMA, respectively. The difference between these two EMAs is called the MACD line. A smoothing method is then applied by calculating an EMA of the MACD line, creating the signal line.
How to Interpret?
When the MACD line crosses above the signal line, as it did last week on the S&P 500, it is considered a bullish signal. Conversely, a bearish signal occurs when the MACD line crosses below the signal line. There are also centerline crossover signals based on the MACD line moving above (bullish) or below (bearish) the centerline.
The chart below highlights the S&P 500 along with its MACD indicator. The bottom panel shows recent buy and sell signals. A histogram is also included in the middle panel to better depict the convergence and divergence between the MACD and signal lines.
As shown above, the MACD indicator flipped back into a buy position last week, marking the third buy signal of this year. The previous two signals proved timely as they coincided with the rallies off of the December and March lows.
How Does MACD Perform?
Since 1950, all MACD buy signals on the S&P 500 have generated average forward three-, six-, and 12-month returns of 2.0%, 4.0%, and 8.3%, respectively. Furthermore, we found buy signals occurring when the S&P 500 was above its 200-dma—as was the case with last week’s signal—historically generated higher returns than buy signals occurring when the index was below its 200-dma.
Considering the S&P 500’s rolling 12-month average return is 8.9% since 1950, and 73% of those periods produced positive returns, it shouldn’t be a major surprise that MACD sell signals did not generate downside losses, on average. The average S&P 500 returns for all sell signals are shown in the table below.
Since 1950, all MACD sell signals on the S&P 500 have generated average forward three-, six-, and 12-month returns of 1.8%, 3.7%, and 8.0%, respectively. All three aforementioned timeframes underperformed relative to the MACD buy signal returns. Furthermore, we found that sell signals occurring when the S&P 500 was below its 200-dma historically generated lower returns than sell signals occurring when the index was above its 200-dma.
The MACD indicator is a useful technical tool to help identify trend direction and momentum. Historically, MACD buy signals have generated above-average returns, with a relatively high frequency of positive returns occurring across most timeframes over the following year. Returns tend to improve when buy signals occur when the S&P 500 is trading above its 200-dma, especially compared to buy signals occurring when the index is below its 200-dma. Sell signals on the MACD indicator are not as ominous as they sound, as they tend to produce below-average, but still positive, returns when the S&P 500 is trading below its 200-dma.
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