A Refined MACD Indicator – Evidence against the Random Walk Hypothesis?

Abstract

Rigorous testing of the widely used MACD indicator results in a surprisingly low success rate of 32.73% for the individually tested NASDAQ- 100 stocks over a 10-year period. This study derives two methods, which address the shortcomings of the MACD indicator. The methods are tested outof-sample to address data-snooping concerns, i.e. to reduce the chance of falsely rejecting the null-hypothesis of no predictability. One version of the second derived method, named MACDR2, results in a success-rate of 89.39%. The performance of method MACDR2 is positively correlated to the volatility of the stock and can be enhanced with option trading. However, the risk-adjusted Sharpe ratio, which is highly sensitive to the implied volatility used in the Black-Merton model, shows mixed results. Shorter or longer exponential moving averages do not improve the success rate of the traditional MACD indicator. Yet the success rate of method MACDR2 is slightly positively correlated to longer exponential moving averages.

Most versions of the method MACR2 outperform the benchmark of holding a riskless security, the Treasury bond and holding the underlying asset, the NASDAQ-100. Thus, this study provides evidence against the Random Walk Hypothesis. However, the results are weakened significantly, if transaction costs and maximum trading constraints are incorporated in the study.