By Stockpickr Guest Columnist Ira Krakow
Jim Cramer doesn’t believe the China doomsday scenario that the financial media talking heads keep harping on. Instead, he sees great opportunity for gains.
If Cramer's right, stocks in Stockpickr's http://www.stockpickr.com/port/China-Watch-Portfolio-February-1-2009/ " target="_blank">China Watch portfolio could be poised for a big rally. The portfolio includes U.S. plays on China, such as Wal-Mart (WMT), Yum! Brands (YUM) and Starbux, as well as more direct Chinese plays such as Baidu (BIDU), Focus Media Holding (FMCN), Ctrip.com (CTRP) and iShares FTSE/Xinhua China 25 (FXI).
Maybe we can get in on the action. In the technician’s universe, "volatility" is not an evil word but rather a sought-after trait. Capturing rapid price swings can lead to quick profits (or even quicker losses).
In this article, I will introduce the MACD, or the moving average convergence divergence indicator, which is used either to confirm the potential buy or sell decision (a “convergence”) or to detect a false positive (a “divergence”).
Then, in my China Watch MACD Analysis portfolio, I'll determine if analyzing the MACD can help us make quick profits.
The MACD Confirms Jim Cramer’s Buy
Here’s a daily candle chart, for one month of trading, from Jan. 13 to Feb. 12, of FXI, with its MACD graph below the chart:
The MACD statistic is based on the exponential moving average, or EMA, a refinement of the moving average, which gives more weight to recent prices than older prices. This is more in keeping with reality than a simple moving average, which treats all prices equally. When making a buy or sell decision based on history, you care more about the what happened yesterday than what happened two months ago, although you don’t want to ignore older prices altogether.
Notice the blue line, the red line and a solid black area. The blue line represents the difference between the stock’s 26-day EMA and its 12-day EMA, the typical settings for the MACD.
If the price has been in an uptrend in the previous 12 days, compared with its movement in the previous 26 days, the upward move has momentum. On the other hand, if the price has been shifting downward for the previous 12 days, compared with its 26-day EMA, this is a downward momentum signal.
The black area, the difference between the two EMAs, graphically shows this strong downward momentum, showing a negative divergence between the two EMAs.
On Feb. 3, about the time of Cramer's call, the blue line crossed the red line, with the black mountain going positive, giving a buy signal (where the "buy" arrow is pointing). The MACD is confirming Cramer's prediction.
An even happier result: Had you actually bought FXI on Feb. 3 (see the "buy" arrow), you would have participated in a nearly 20% runup, from Feb. 9, from $25 to $29.
Note the black mountain, which is an indicator of the strength of the move. When the height of the mountain increases, this means that the move is strengthening. When the mountain’s height decreases, however, that shows that the move is weakening and that it’s time to sell.
If you had played the MACD with that in mind, you would have sold (see the "sell" arrow) on Feb. 9, a gain of nearly 20% in a week.
Finding the Best China Stock
Your assignment is to see if you can day trade China stocks with the MACD. Day traders see profit opportunities on a minute by minute basis. Let’s see if we can do it as well.
Step 1: On Stockpickr, create a portfolio called “China Stock MACD Day Trades: [Your Stockpickr Username]". (To create a portfolio on Stockpickr, you'll need to first log in. If you're currently not a Stockpickr member, register here.)
Step 2: Add three of the the stocks in my China Watch MACD Analysis portfolio to your portfolio.
Step 3: Using your favorite charting software, such as BigCharts , plot an intraday candlestick chart, generating a candle every five minutes, and the MACD. Based on the MACD, identify your buy and sell opportunities. Experiment with different time frames, such as 15-minute or 30-minute candles. Document the times and prices for your trades in the Reason for Picking box. Check back during the day to see whether other buy and sell opportunities occurred.
Step 4: Repeat Step 3 for the next three trading days or until you feel comfortable trading real money.
Don’t Rely On One Single Indicator
As with any other technical indicator, the MACD isn’t perfect. Sometimes the MACD inches a bit above the zero line, only to reverse quickly. Experiment with other settings, other than the standard 12- and 26-day periods, for the EMA. Traders looking for more buy and sell signals sometimes use the 8- and 17-day period moving averages, for example.
Combine your MACD analysis with other technical signals to confirm the signal.
One of the most common problems that a stock technician faces is that not all buy or sell signals are genuine. A signal, such as a bullish candle on a one minute http://www.stockpickr.com/problog/1385/ " target="_blank">candle chart, a stock price crossing its 20 day moving average or the price touching the upper Bollinger band, may be only a temporary blip. The next minute, the price might reverse sharply.
Placing a buy order relying on one indicator over a short time frame -- a false positive -- could result in a big loss.
Posted on Feb. 13, 2009
Editor's note: David Peltier will be on Stockpickr Answers today to respond to questions posed by members of the Stockpickr community. Not a member? Join the Stockpickr community today - for free.
