Dec
7

Basic Chart Reading – Multiple Confirmation with MACD and Stochastics SlowK

Many beginners try to learn chart reading too quickly, leaving most of the important details behind. I am going to review some of the basic chart reading techniques, hopefully that will help the beginners to read their charts better.

Charting the MACD and the Stochastics SlowK

The following chart has 2 indicators applied onto the Emini S&P 15-minute chart.

1. A Simple Moving Average based MACD with parameters set to 5 period and 8 period

2. A SlowK indicator with parameters set to 5 period and 3 period.

Here is the chart,

Basic Chart Reading chart1

First, why am I using such parameters?

The answer is quite simple – the parameters I use for SlowK is the default parameters for SlowK since it was first created. The parameters I choose for the MACD is to mimic the SlowK so that I can compare them apple to apple.

Disadvantage of Working with a Single Time Frame

When we are working with a single time frame, the information available is limited to the one single data series. In order to extract more useful information from this data series, the only way is to apply different filtering techniques to extract different kind of information from the raw data.

For example, MACD can provide useful information on the strength of each swing in price movements, but it is not very good at identifying possible overbought and oversold conditions.

On the other hand, Stochastics SlowK can be used as an early warning tool for possible overbought and oversold conditions.

When we use them in combination, we can identify turning points with more confidence.

Divergence and the Importance of Multiple Confirmations

In the chart, I have labelled a series of divergence setups from 1 to 5.

Setup 1 and 4 show that the MACD (forming a lower high) is diverging from the price action (forming higher high) while the SlowK (forming a higher high) is confirming the price action. The inconsistencies between MACD and SlowK lead to less predictable results as the actual price reversals happened much later. In these cases, if you use only MACD as your trading signal, you would then need to take extended heat before the price actions going your way.

Setup 2 and 5 are the classic perfect divergence patterns that the MACD and the SlowK both exhibit lower highs while the price action is forming higher highs, that leads to more predictable price actions which are easier to handle in real-life.

The Most Ignored Pattern by Beginners

Setup 3 is an interesting pattern that is most likely ignored by the beginners while experienced traders are more likely to take the trade. Setup 3 is simply a continuation pattern.

Setup 3 has confirmed lower highs across the price, MACD and SlowK. It is the formation that is easiest to ride.

Due to the fact that it does not have the glamour of picking the high, and has the insecurity of selling near the low, many beginners simply avoid this type of patterns. In fact, this pattern is probably much easier to trade comparing to the divergence setups.

Other Indicator Combinations

I choose MACD and SlowK as a pair because they are not exactly the same type of oscillators. SlowK is range bounded while MACD is not. Each indicator gives you a perspective to understand the price actions.

You can choose other combinations of indicators to archive similar results.

For example, CCI and RSI are known to work pretty well together. CCI is not range bounded while RSI is.

If you spend enough time to understand the unique perspective offered by each indicator you use, you will be able to get a lot more from your charts.

Discuss this article.

2 Comments on “Basic Chart Reading – Multiple Confirmation with MACD and Stochastics SlowK”

  1. Stuart Miller Says:

    Can NT be programmed to automatically spot divergence setups #2,3 & 5, and plot appropriate labels on price plot?

  2. Lawrence Chan Says:

    To detect #2, 3, and 5 are easy. The hard part is to be able to participate in the trades, that early warning is needed as oppose to detect a “confirmed” formation, which is useless in my opinion. You can take a look at the article on end-of-day setup based on entering the market when stochastics looks its worst. To trade divergence successfully, stepping in at the right price level is key to success. When I have time, I will write about techniques in automatic detection of divergence setups in MACD and Stochastics.

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