Welcome to the second indicator study. This research represents an investigative look into how and why some indicators work better than others.
New Versus Old
As we mentioned in the first indicator study on the Hull Moving Average, the premise behind these studies is to explore more efficient indicators, which may yield superior results than older indicators that were suited for different markets of a bygone era.
Our Second Indicator Choice is…
We’ve chosen the Zero-Lag MACD (Moving Average Convergence Divergence) as our second choice. Over the years, there have been variations, tweaks to settings and calculations but essentially, the math behind all MACD indicators revolves around the use of different moving averages. And, like moving averages, the MACD was a staple among a handful of indicators found in a trader’s toolbox.
The original MACD was developed way back in 1979 by a guy named Gerald Appel and, for the most part, was a pretty good thing, especially for stock traders who used it in various ways, but it had its limitations and was generally too slow for Forex traders, which we’ll point out shortly.
The Zero-Lag MACD was developed by John Ehlers and Rick Way in 2010 and lives in the space below the price chart, something we term as a “below-chart indicator”. (see snapshot below) and we consider it a “confirmation indicator”. And, since it’s faster, some like to refer to it simply as a zero-lag indicator.
A “confirmation indicator” falls into the category of indicators that serve as an initial checkpoint after the baseline indicator (see the blog on HMA for baseline indicators HERE) when setting up your algorithm. These concepts are explained in great detail in the Stonehill Forex Advanced Course (HERE).
Similar in appearance to most types of MACD indicators, the math in the Zero-Lag version attempts to provide advantages, including;
- Reducing lag and reaction time
- Emphasizes more recent market prices
- Aids in identifying prevailing market trends
The setting includes; Fast EMA, Slow EMA and Signal EMA. The default settings are 12, 24, 9. Before we take a closer look, I’ll explain what each parameter represents.
Fast EMA: This setting controls the number of bars used on the faster underlying EMA (Exponential Moving Average) line.
Slow EMA: This setting controls the number of bars used on the slower underlying EMA (Exponential Moving Average) line.
Signal EMA: This setting allows users to adjust the number of periods the signal line would compute for the EMA of the MACD bars.
Below is a screenshot of what the indicator looks like on the daily time frame. Note that we’ve changed the color of the candles to white to remove any emotional bias so that only the indicator is prominent.
How we Use it
Generally speaking, traders use MACD indicators in three different ways;
Since we are not reversal or divergence traders, we ONLY use MACD indicators as trend identifiers by taking signals when the signal line crosses the “zero line”…thus, we call this type of indicator a “zero line cross” indicator.
Additionally, we don’t use the histogram (pink bars), so they can be removed as well, if you choose, making this indicator a very clean addition to your charts.
As mentioned in the HMA study, we strongly advocate backwards and forward testing indicators or systems prior to trading actual funds, the task of manually sorting signals through more than 70-130 available currency pairs is daunting at best. That being said, we suggest conducting your tests on the following five pairs.
Recall that if it doesn’t work on these five pairs, chances are it won’t work on other pairs. Granted, this is not an absolute, but we’ve found that this rule is pretty reliable in most cases.
Timeframes and Results
In our initial test, we’ll run the Zero-Lag MACD on the EURUSD using the default settings 12, 24, 9 across the daily and 4-hour timeframes on the MT4 strategy tester. We’re using the fast method of testing the indicator to get a general idea; however, you may also run the tick-by-tick data set for a more precise result (which takes considerably more time).
As No Nonsense Traders – and therefore swing traders, we won’t be examining shorter time frames in these studies. Then we’ll run multiple iterations using combinations of the three settings to see which ones work best and examine the results:
1. Total trades
2. Win/Loss ratio
3. ROI (return on investment)
There are many other metrics included in the strategy tester report, which can be compared, but these three metrics provide the necessary gauge to make quick decisions as to the usefulness of a particular indicator and its settings.
For comparison, we’ll explore the following;
Daily – 1 year
4-hour – 3 months
The reason we don’t include exceptionally long (or short) testing periods is due to changing market conditions, which might return irrelevant information. A balance of statistically significant data is necessary for accurate results.
And the Outcome…
Below is a spreadsheet listing the results from our tests.
You can see that the green highlighted rows represent the best settings for that time frame when all the indicator settings have been taken into consideration. Please keep in mind that this changes over time and should not be considered specific trading advice.
For those who are curious as to what money management we’re using on our tests; we’re only using a stop loss of 1.5 x ATR and take profit of 1 x ATR. We’re only determining how well the indicator reacts to price with respect to generating a long or short signal. Your system, with its risk profile, will dictate individual returns. The stop loss and take profit levels are based on the No Nonsense Forex methodology, which can be found in the Advanced Course by clicking HERE.
Now that we’ve demonstrated some benefits of this indicator, you may wonder where it can be found. A simple Internet search will yield useful results. Or, you can download it from the indicator library on this site HERE!
More to Come
There’s a lot more to come. If you haven’t signed up on our contacts page or subscribed to the YouTube channel, please consider doing so to receive notifications as we continue to publish helpful, relevant, and informative Forex related material to support your quest to becoming a better trader.
And, now you are aware of an indicator that many traders don’t know, or use.
Our only goal is to make you a better trader.
BTW – Any information communicated by Stonehill Forex Limited is solely for educational purposes. The information contained within the courses and on the website neither constitutes investment advice nor a general recommendation on investments. It is not intended to be and should not be interpreted as investment advice or a general recommendation on investment. Any person who places trades, orders or makes other types of trades and investments etc. is responsible for their own investment decisions and does so at their own risk. It is recommended that any person taking investment decisions consults with an independent financial advisor. Stonehill Forex Limited training courses and blogs are for educational purposes only, not a financial advisory service, and does not give financial advice or make general recommendations on investment.