MACD Whipsaws and Fake Out Signals on Bearish and Bullish Territory
since the MACD is a leading indicator which sometimes give whipsaws, we shall look at an example of a whipsaw generated by this indicator, so as to illustrate why it's always good to wait for a confirmation signal.
The MACD indicator gave a buy signal, when this was generated and the indicator line was still below the zero mark. At this point the buy signal had not been confirmed and it resulted into a whipsaw as illustrated by the moving averages which continued to move downwards.
A whipsaw is as a result of dramatic rise and fall in the price in a short time and in such a manner that skews the data used in calculating the averages. These types of moves are usually brought about because of some news event that can produces market noise.
Traders should have the ability to gauge a whipsaw and withstand the whipsaw; a whipsaw might result into an upswing session and then a downswing session. To minimize the risk of trading whipsaws, it's good to wait for confirmation of signals by waiting for MACD to cross above or below the zero center-line mark.
Combining MACD Crossover with Center-Line Crossover to Prevent Whipsaws
Buy signal - When there is a crossover, followed by a steep rise in price and then a center-line crossover the buy is confirmed.
Sell signal - When there is a crossover, followed by a steep decline in price and then a center-line crossover the sell is confirmed.
1. Buy signal in Bearish Territory Whipsaw
When a buy is generated in a bearish territory, it might result into a whipsaw especially if it is not followed soon by a centerline crossover.
In the example below, MACD gives a buy signal even though it is in bearish territory, the indicator then turns downwards and starts moving down again resulting into a whipsaw. By waiting for center line crossover it is possible to avoid the whipsaw. However, in this case there was a brief center line crossing; this whipsaw would have been hard to trade using this indicator alone, that is why it is good to combine the use of MACD with another technical indicator. In the example below the it is combined with the moving average technical analysis.
Whipsaw - Buy signal in bearish territory
2. Sell Signal in Bullish Territory Whipsaw
When a sell is generated in a bullish territory, it might result into a whipsaw especially if it is not followed soon by a center-line crossover.
In the example below, the indicator gives a sell signal even though it is in bullish territory, the indicator then turns up and starts moving upwards again resulting into a whipsaw. By waiting for center-line crossover it is possible to avoid the whipsaw. In the example below by combining this indicator with the Moving Average Crossover Trading System you would have avoided this whipsaw.
Whipsaw - Sell signal in bullish territory
To avoid whipsaws completely when trading with this Indicator it is best to use the Center-line Crossover as the Official Buy or Sell Signal of The MACD Indicator.