MACD CROSSES OF THE ZERO (CENTER) LINE

Throughout our last several Swing Trader issues I have commented on a possible MACD cross of the zero, or center, line. This is an extremely important signal that in the past has marked vital transitions from bull to bear markets (and vice versa). I want to review the history of that signal with you in an effort to get you to fully appreciate its significance.

I review the calculation behind MACD in my special report -- "MACD: My Desert Island Indicator." I won’t repeat the full details here, but I will remind you that MACD is calculated by subtracting a 26-period exponentially smoothed moving average from a 12-period moving average. I call the line that is formed the "main line." A nine-period moving average of the main line then becomes the trigger for buy and sell signals.

The zero, or center line, crossover occurs when the 12- and 26- period moving averages move either below or above each other. As with all moving average signals, when the shorter moving average crosses above the longer, it provides traders with a bullish signal. Meanwhile, the reverse is bearish. Note that the center line crossover is independent of whether MACD is itself on a buy or sell signal, since it does not incorporate the 9-period smoothing line.

Below you'll find a weekly chart of the S&P 500 dating back nearly six years to January 1998. In the last six years, we have only seen three crossovers of the MACD zero line! Each time it has heralded a major move in the market. As such, this is a signal you don't want to ignore. (In all the technical analysis reading I do on the web, I have found no other commentators who have mentioned this signal. Swing Trader subscribers are the only traders I am aware of to be apprised of this information.)

In addition to the three crossovers, MACD has approached the zero line on three other occasions. In each of these instances, however, this line has served as either support or resistance and has turned MACD back. The crossovers are labeled 1, 2 and 3. The support/resistance approaches are marked A, B and C.

The first cross of the zero line at "1" occurred in the Fall of 1998 with the S&P near 1100. MACD rose to an overbought level of 50 on its scale and began to show bearish divergence, as MACD trended down while the S&P itself continued to rise. At point "A" in late 2000, a sharp Intermediate correction brought the S&P from just over 1400 back to just north of 1200 in the span of just a few months. Note how the zero line served as support on this correction. When MACD gave a buy signal just after "A" -- soon after the test of the zero line -- a fierce rally ensued.

After nearly two years of bearish divergence, MACD finally broke through the zero line at point "2" in the Fall of 2002. The signal was given at approximately the 1400 level on the S&P. An investor who heeded this bearish crossover would have avoided the deepest bear market since the 1930s. The S&P lost almost -50% of its value before hitting bottom in October 2002 at 768. It is worth observing that in early 2002 at "B," MACD rallied back to the zero line and that level served as resistance. During late 2002 to early 2003 the index peaked on three separate occasions between 1173 and 1177. That level is, of course, just above the March 2004 peak of 1163.23 and is a resistance level the index is still struggling to overcome!

I have discussed numerous times in this newsletter the triple-bottom formation that took place between July 2002 and March 2003 -- a formation that officially ended the bear market. Note that during that time, MACD showed bullish divergence -- the mirror image of the bearish divergence of 1999-2001.

The bullish cross of the zero line occurred in late Spring of 2003 (point "3") near the 965 level on the S&P. The penetration of this key resistance level completed the triple-bottom formation. The S&P remained in strong rally mode until March 2004. Since that time, however, the index has made a series of lower peaks and lower valleys -- indicative of an Intermediate downtrend. As seen at point "C," MACD retreated below the zero line in August 2004 before rallying slightly over the last couple of months.

At present, weekly MACD is at 2 on its own scale and has managed to hover just above the zero line. The next major move in this indicator will be a telltale sign of whether the market is going to return to technical health or whether another bear market will ensue.

If the market is to become healthy again, then there should be a bounce off the MACD zero line and MACD should return to a buy signal. If a bear market is upon us, then MACD should go below the zero line and start trending down again. As of now, the final outcome is still in doubt. However, you can be assured I will be watching this indicator microscopically for the first hints of its coming direction. Swing Trader subscribers will be the first to know my conclusions!

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