Next-Generation Lists

Using the MADI indicator

On this page:

• Interpreting the MADI
• Using MADI and VMI together

Interpreting the MADI

Stock is in Positive Territory:
Both numbers Positive Ex: 02:03	The stock is above both the 20-day and 50-day averages, a show of strength. This generally indicates the stock is in an uptrend, with an RSI over 55. Of course, the MADI values could be falling and still be positive. Positive means positive, not necessarily uptrend.
Likely Uptrending Stock:
50 MADI is Larger Ex: 01:03, 02:04	This suggests that the stock is in an uptrend but tells us that the 20-MA is above the 50-MA, and the stock is above both. Of course, the MADI values could be falling and still be positive. Positive means positive, not necessarily uptrend.
Narrowly-Ranging Stock:
Both Numbers are the Same Value Ex: 03:03, 00:00	This tends to happen in the case of a stock that has been narrowly ranging long enough for the 20- and 50-day averages to converge, or almost converge. Remember that there is some play in the MADI reading.
Potential UPSIDE Reversal:
20-MA Negative 50-MA is 00 Ex: -01:00, -02:00	These are are money MADIs. When the 20-MA is -01, -02 or -03 and the 50-MA is 00, the stock is signaling a potential reversal off support. These MADI combinations are not guaranteed, but they have turned up many great trades for me.
Stock is in Negative Territory:
Both Numbers Negative Ex: -02:-04	The stock is below both the 20-day and 50-day averages, a show of weakness. This generally indicates the stock is in a downtrend. Such a stock usually will have an RSI under 40 and can be quite oversold. The bigger these numbers are, the worse. Occasionally, however, it will indicate a recovering stock that has not yet risen to to either average.
Need help visualizing the MADI?

In the preceding page, you saw how to visualize the MADI. Practice helps if you work with the MADI values on our lists and pay attention to them.

The next segment shows you how to use the MADI and VMI together. Educating yourself on using them in tandem can only improve your trading, and your charting skills as well.

Using VMI and MADI Together

I hope you are getting excited about this little excursion. This is how I do it, folks, how I find some really swing-for-the-fences trades. And some of them are not immediately intuitive, except to a trader. But you can learn to do what I do. It just isn't that hard.

If you write OTM calls, which means less premium up front and less downside protection, you should have a reason to believe the stock will rise before expiration.Why will it rise? I'm not talking medium- or long-term here; that is for portfolio stocks.

An uptrending stock normally is above both the 20-day and 50-day averages. When it pulls back to test support at the 50-day average, it will have a 50-MADI value right at (00), and will be even further below the 20-day average and have a negative 20-MADI (ex: -01, -02 or -03). This can be one of the best covered call trade entry signals of all, because it is a signal the stock may be testing support and (potentially) poised to snap back higher. I tend to write these OTM, because doing so offers a steaming return if I am correct. And OTM writes on these bulls allows a profitable early close to the trade. This strategy works well for naked puts, long calls, bull put spreads and bull call spreads, and any other strategy that needs a fast-rising stock.

QUERY: Can this technique be used for longer-term call writes? Of course. You simply use a weekly chart instead of a daily and catch a bounce off major support on the weekly chart.

Down-Day Writing:
This logic also applies when the stock has pulled back a few days or a week in tandem with a declining market. Writing stocks doing this is known as down-day writing. Think about it: the down-day candidate has pulled back, usually to the 20-day or 50-day average, along with the major stock indices. When the market snaps back, the stock likely will, also. This is like shooting fish in a barrel when sticking to top-notch companies.

Potential Upside Reversal off of Support

The flat arrows only intimate a possible reversal.

A stock or index, after finding support, often will rebound on low volume. These MADI values are powerful when they coincide with these arrows:

Support Being Tested on Volume Now

What if the arrows are not flat, but huge, with the same MADI values?

The large arrow suggests that the stock or index is testing support on volume - but it is in the middle of the test.

Granted, these are not the only good short-term bullish signals, but think about it... every bullish setup involves either 1) a volume test of some support level, or 2) a breakout above a range or wedge. I have found tests of support to be far more reliable when dealing with high-quality stocks.

All price runs up come to an end at some point. And that point is a resistance level. Resistance may be the top of a trading range, a major moving average or a previous high. While a stock may in fact break through the looming resistance level, odds are it will not, and writing a stock that is extended and approaching resistance really is just a speculative bet - for which covered call and naked put writing are entirely unsuited.

When a stock becomes extended (overbought), it will have high positive MADI values, usually 03:05 or higher, maybe much higher. At really high levels, such as 09:11, the stock really has shot into the troposphere. Such stocks are coming back down, and sooner rather than later.

These kinds of MADI values are not entry signals for covered calls or naked puts, but can be an excellent signal for: bear call spreads, bear put spreads, naked calls, long puts or any strategy that needs a falling stock.

Overextended: Potential Reversal and Selloff

High MADI values indicate the stock or index may be overbought, and flat arrows may indicate that it has failed at resistance and is headed downtown.

Overextended: Resistance being Tested Now

High MADI values indicate the stock or index may be overbought, and large-volume arrows may indicate that resistance is being tested.

Most, though not all, sell-offs come to an end at some point. The stock in a sell-off will break below the 50-day moving average and lower trend line (they may be the same) and head south. Even more serious, the stock may break below the 200-day average, which is a serious correction. Assuming the (high) fundamental quality of the company has not changed, the stock is undergoing a retracement to its uptrend. This is normal and healthy, if a bit scary, and should be seen as a potential buying opportunity. (If the stock was not in an uptrend when the sell-off began, then this reasoning likely does not apply.)

Stocks of good companies, whose fundamental quality has not deteriorated, will retrace from an uptrend at some point. The stock typically will fall either to the 200-day moving average, although it may go even further down or not quite that far, to a major support level. Bonus points if the 200-day average also happens to be at a major support level. When the stock finally does find support on volume, it often will come roaring back and presents a breathtaking covered call and naked put opportunity - and works with any option strategy that wants a fast-rising stock.

Not for newbies or the faint of heart, experienced chartists will appreciate the power of such a setup. The examples following show ways to find potential candidates.

The MADI values actually can be greater than these, or even lesser. These are fairly extreme values and worth checking out.

Ailing Stock that is a Potential Upside Reversal

High negative MADI values indicate the stock or index may be oversold, and flat arrows may indicate that it has found support and is headed uptown. If a reversal seems to be occurring, this is a great play.

Ailing Stock Testing Support Now

High negative MADI values indicate the stock or index may be oversold, and large-volume arrows may indicate that a test of support on volume is in progress. Too early to enter - wait for confirmation.

Important Bear Market Note:
In a bear market, the market (and most stocks) rise and fall in declining waves between two identifiable trend lines. This is known as a declining range. Although we do not write covered calls or naked puts on a declining stock when it is in a down-leg of its trading range, the stock can be a marvelous trade candidate when in an up-leg of its declining range.

During a bear market, this is where I make most of my money. The entry signal comes when the test of support - the bottom trend line - is completed on volume. This signal using the above MADI values is very powerful when it leads us to the right chart.

If a stock tends to move with its relevant index and that index is showing the same MADI and VMI values, it can indicate that the stock move is occurring with its index - and therefore its industry. This adds confirmation to the stock's move.