How To Find and Trade MACD Divergence
How do you find MACD Divergence trading Ideas like COST that resulted into quick gains? This post will explain process of finding divergence play without paying hefty sums for datafeeds or premium charting tools. All it needs is a FREE stock screener, a FREE stock charting service and a few skills to read charts. Before I begin, I am assuming that you already know “What is a MACD Divergence?”
The next step is all about the following 1, 2, 3:
- Finding and selecting appropriate underlying vehicles,
- Structuring and Placing the trade (Before placing a trade it is, however, important to know whether overall market is in uptrend or downtrend. If your strategy is in sync with overall market direction, chances of your success will increase dramatically) and
- Exiting the trade.
Let’s move on to the first step i.e. To find suitable underlying. You can use, any FREE stock screener of your liking, I prefer FinViz and here are my criteria for the search-
- 0-3% below 52wks high
- Last price > $20
- Average Daily Volume > 750,000
- Underlying should be Optionable
- Bid/ask slippage needs to be as narrow as possible
- If options are not liquid, it’s ok to pass the opportunity to other day
You can save this screen on Finviz. Next time, it will require less than 5mins to filter possible underlyings.
Let’s continue with the process of selecting underlying-
- Running the filter provides tickers [122 as of Yesterday closing. The names vary from Crocs, Inc (CROX) to Tiffance & Co. (TIF)]
- Export resultant screen to excel.
- Sort symbols via volume, followed by Price.
- Choose TOP 20 from the list and review one by one on a six month chart. The chart settings are-
- Daily Candlestick Price
- MACD 2lines + Histogram (12, 26, 9)
- Volume and Volume Average
- Previous Support & resistance levels
A picture is worth 1,000 words and some more. As there may be many interpretations of a chart, let me share what I look for? My preference is to find patterns where price is making new high but shows clear sign of divergence either via MACD or via Histogram. Let’s begin with the process of viewing charts:
- MACD divergence i.e. Price Making Higher High but MACD Histograms/ Signals making Lower High.
- Is the new high near any past resistance level?
- Check relevant news on underlying to find out if there are any M&A, FDA etc news that will rally it higher in spite of divergences?
- Review if volume is endorsing the move?
- Project extent to which underlying might fall before it find next level of support?
- After a projection has been made, choose appropriate bearish strategy
- Bear Call Spread
- Bear Put Vertical
- Bear Put Back Spread
- Straight Put buying or Call selling, etc.
- Wait for the underlying to confirm the reversal
- Choose an appropriate STOP/ Exit e.g. profit target might be based upon ATRStop, Profit % or a predetermined target where Risk:Reward ratio is 1:2
There are many ways you can enhance selection process further e.g. you might want to add moving averages, momentum indicators, Fibonacci levels. Whatever you choose, keep it simple in way that works for you. Though I have had wonderful success with this, I’ll suggest not to invest all of your money based on this strategy alone. Use it with due diligence and proper capital allocation and beware of the fake divergence as well. In the next discussion on Divergence, I shall share on how this can be further tweaked.
I would like to reinforce that it is important to know whether overall market is in uptrend or downtrend. If your strategy is in sync with overall market direction, chances of your success will increase dramatically. The same concept can be used even for short-term trading e.g. day trading.
I am not listing specific trade ideas here. How about you check out few underlying based on what you learned from this post and share your thoughts in the comments section to open it up for discussion.
Profitable Trading, OP
(Disclaimer– As of this writing, I am short TIF. But I may change/close my positions anytime without posting here)