Technical Analysis - Comparing Tools
Market Indicator for the Week Ahead

Technical Indicators – Flashing “BUY” Signals

by Ian Harvey

June 25, 2012

Introduction

Technical analysis involves evaluating a stock simply by looking at its price chart. There are a lot of tools used these days for analysis that are available on pretty much any charting software. This week, a look at some of the more popular technical indicators is undertaken, to see which ones have worked the best and worst over the past several years – and how they may be applied to trading in the week ahead – particularly after last week’s upset.

As you are probably aware, stocks ended modestly lower last week, despite relatively predictable Greek elections and an extended bond-buying program from the Federal Reserve. Weighing on Wall Street was the central bank's downwardly revised forecast for inflation and economic growth, and upwardly revised projection for the U.S. unemployment rate. Exacerbating those concerns was a wash of dismal domestic data on Thursday, including a disappointing report on Philadelphia-area manufacturing, and a jump to year-to-date highs in the four-week moving average of initial jobless claims.

However, there's more than one "buy" signal flashing right now -- on the technical, sentiment, and historical fronts – and this will help dissect the most accurate technical analysis indicators of late, as well as help highlight a few potential stocks to keep an eye on!

The Technical Analysis Indicators

This study involved going back to 2007 and looking at optionable stocks that averaged at least a million shares traded daily and closed above $5. Taking a simple look at some technical indicators, and finding the dates on which stocks had a "buy" signal, and then finding their stock returns over the next month – provides a list of the indicators and a short description that was worth considering:

RSI: The RSI (Relative Strength Index) is an oscillator that ranges from zero to 100. A low-number reading suggests a stock is oversold and ready to bounce. A typical "buy" level for this technical analysis indicator is when it falls to below 30.

MACD: The (Moving Average Convergence/Divergence) is calculated using the difference in two different moving averages for a stock. A moving average of that difference is then used and called the signal line. A common "buy" signal is generated when the MACD crosses above that signal line.

The Golden Cross: A golden cross is when a shorter-term moving average crosses above a longer-term moving average. In the analysis below, the 50-day and 200-day moving averages are used.

• Moving Average Crossover: This is simply looking at the stock crossing above a certain moving average. As comparison of returns after the stock crossed above 50- and 200-day moving averages is used.

Bollinger Bands: These use a moving average, and then bands are placed two standard deviations above and below that moving average. When the stock touches the lower band, it is often considered oversold and a bounce in the stock price is expected.


The Results

Below is a table summarizing all results since 2007. Some indicators signal much more than others, as we see the MACD and Bollinger Bands generated over 20,000 "buy" signals each, while the golden cross signal only had about 3,500 "buy" signals. The table shows the MACD and Bollinger Bands were the best indicators over this time frame, going by average return. A golden cross showed positive returns as well, while the other "buy" signals all led to losses in the stocks, on average.


However, when dealing with the stock market, technical analysis indicators tend to fall in and out of favor. Therefore, by breaking the returns down to look at the signals generated this year only, the table below is produced, which shows us what signals have been best in more recent times. Note that all signals are showing negative average returns except for one: a crossover of the 50-day moving average. It's also the only technical analysis indicator with over 50% positive returns. The MACD, which was the best indicator since 2007, averages a 1% loss after a "buy" signal for 2012. Yet the MACD is still the second-best signal for the year, since it's the least negative of the other signals.


The 50-Day Crossover Last Friday

There were a significant number of stocks crossing above their 50-day moving averages last Friday. Knowing that these signals have worked recently, it would be prudent to suggest that this may be a good starting place to be looking for short-term trades. Below are liquid stocks that broke above their 50-day moving averages on Friday and have gained at least 10% so far this year.

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