Home Starts, Homebuilders And Histograms

02/19/04 09:41:47 AM

by David Penn

MACD histogram peaks near the 50-day moving average can be a bearish sign of things to come.

Security: $HGX
Position: N/A

In the play, "No Exit," by notorious existential philosopher and Communist fellow traveler Jean-Paul Sartre, hell is less a place of eternal painful torment and more a place of everlasting loathing and a banality that is all the more excruciating by its endurance. This version of hell was not unique to Sartre. We saw something similar in Beckett's theatrical masterpiece, "Waiting for Godot," in more than a few late night episodes of "The Twilight Zone" and "Alfred Hitchcock Presents" . . .

. . . And in the trading range the homebuilder's index, $HGX, has been mired in since November 2003.

First, let's take a quick look at how the homebuilders got this way. Like the rest of the broader market, $HGX broke out of the summer consolidation in September 2003. As the chart shows, the 50-day exponential moving average (EMA) was effective support for the post-August rally that saw the homebuilder's index move from around 300 to 370 by early December. It has been since that time that the $HGX has been trapped in a range between 370 and about 350.

With a few hours to go in the trading day, a lower MACD histogram bar may mean a short-term top in the $HGX.

Graphic provided by: eSignal.

In other articles for Traders.com Advantage and Working-Money.com I have pointed to ways to use the MACD histogram as a signal for buying oversold markets. The histogram, recall, is simply a measurement of the distance between the MACD's two exponential moving averages. As such, the histogram does a great job in helping traders and investors spot instances in which selling power is waning. I've become a huge fan of the MACD histogram: in his book, The Visual Investor, John Murphy refers to the MACD as "the best of both worlds" and to the histogram as a way of "mak(ing) the MACD even better." If that's not a hint to pay more attention to the MACD histogram, then I don't know what is. Dr. Alexander Elder has also been an advocate of the MACD histogram as a great tool for traders (see his book Trading for a Living).

Because the MACD and the MACD histogram can function in both trending and range-bound markets, these tools may be especially helpful in dealing with the homebuilders index, which has displayed the capacity to trend as well as it consolidates. Presently, $HGX has moved toward the top of its trading range. The MACD itself is not especially overbought (though the 7/10 stochastic is), but the histogram appears to have peaked on February 17th and is today, on the 18th, making a shorter bar.

Often, in trending markets or in markets that are trading above their 50-day EMA, this would not be a particularly reliable sell signal in and of itself. Waiting until prices move below the low of the "shorter bar" (the lower, post-peak histogram bar I have referred to elsewhere in other articles on the topic as "the point" or "the point bar") is the main way to improve the accuracy of this signal, other than abstaining from taking short trades above the 50-day EMA, which is pretty wise counsel. Nevertheless, in a range-bound market in which prices appear incapable of escaping the gravitational pull of the 50-day EMA, a peak and a pullback in the MACD histogram can be a good signal for a short-term opportunity to the short side.

This morning's news brings word of a "sharper-than-expected" nearly 8% drop in U.S. housing starts. While this is the sort of fundamental news that one would expect to accompany a homebuilder's index that has not moved significantly since November (housing starts are reportedly at their lowest levels since August 2003), most economists have brushed off the news, attributing it to "bad weather" (a typical dodge). Technical traders have no better idea of whether this drop in housing starts will signify a collapse -- or even a temporary correction -- in the $HGX. But no doubt they will be better off paying more attention to technical tools like the histogram, than fundamental tools like housing starts.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Home Starts, Homebuilders And Histograms

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