Using Percentage Based MACD to Manage Risk

This blog has been in existence for almost four months now. In this time, I have selected many stocks that would have been very profitable. I must also admit though that many others would have lost a lot of money.


I feel that in order to improve results, we should focus more closely on the stock trading techniques of market legend Jesse Livermore. Besides being made famous for his trend trading strategies, Jesse Livermore was also known for his risk management techniques. Livermore would set tight stops on all his positions, which meant that he would take many small losses. These small losses were more than made up though by the occasional gigantic gain.

With this in mind, this strategy requires more focus on risk management. The rules of this strategy dictate that the stock should only be dumped when the 50 day moving average (dma) is broken. Therefore, it is integral to determine how far the stock is from the 50dma. This is such an important piece of information because it represents the amount we are willing to lose before discarding the stock.

Fortunately, there is an easy way to determine how far a stock is from its 50dma by using an indicator called the PPO. The excellent website, StockCharts.com, has a very thorough explanation of many types of indicators including the PPO here.

The PPO essentially is a percentage based version of the MACD (moving average convergence divergence). The PPO takes the percentage difference between 2 moving averages, and then takes a moving average of that difference.

If we tell the PPO to take the difference between the 1 day moving average of price and the 50 day moving average of price, and then take a 1 day moving average of the difference, then it will tell us the information we are looking for.

Here is this week's mega-trending stock with this new indicator. The PPO will make a lot more sense when seen in context, so here it is:



I think the above chart shows how powerful StockCharts.com can be. I have spent thousands of hours tinkering with Stockcharts.com's features, and I am still finding out new things. There is no technical analysis tool that I could recommend more highly than StockCharts.com.

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