Charting is essential to consistently successful covered call writing. We at CallWriter have long known that. But having said that, a couple of questions immediately are raised:

1. What length chart should be used?
2. How can the stock's price action be confirmed by different charts?

The time frame (chart length) of the chart is the very first choice the analyst makes when setting up a chart. Every price bar on the chart will be of the time frame chosen. Thus on a daily chart, every separate price bar will be for one day, and each bar will represent the low, high, opening and closing prices for that day. On a weekly chart, each bar represents a week, and on a 10-minute chart every bar represents a 10-minute period of trading. This affects all studies used on the chart obviously. By example, if a 14-day moving average is added to a daily chart, it is in reality a 14-bar moving average; it is only a "14-day" moving average because a daily chart is being used. On a weekly chart, the same 14-bar moving average would be a 14-week moving average, and on an hourly chart it would be a 14-hour moving average.

Covered call writing as we practice it at CallWriter is an intermediate-term (medium-term) trading strategy. Our typical trade length will run from three to five weeks. For us, a 60-day trade is pretty long and we rarely are in one that long, unless we have rolled the calls out in time or we are writing our way out of a problem. The time you anticipate being in the trade is is a very important consideration, since the chart length must take expected trade duration into account. A futures day trader for example might trade off 1- and 3-minute charts, and for him a one-hour trade might be a long one.

For our relatively intermediate-term trading, we find the ideal charts to be the daily chart and the hour chart (a/k/a the 60-minute chart). A chart with a shorter time frame than an hour is too jerky and noisy. A time frame longer than daily (e.g., weekly) generally is too slow and lagging, although they sometimes are handy for obtaining perspective on the stock's longer-term trend.

Next, your assessment of price action - the current formation you see on the chart - will almost always be better if it is confirmed by a different length chart. By this we do not mean that both charts should be showing you the same thing, the same formation. That will rarely happen with charts of very different lengths. What you are looking for is a trading opportunity - or a trade to avoid - that one chart alone would not show you. Sometimes formations that are not readily apparent or that are just forming can be revealed this way. Frequently one chart is ahead of the other and you can only see this by comparison of both charts. If you don't compare, you don't see.

At CallWriter we like to use a daily chart for analysis and confirm the action with the 60-minute chart. Some covered call traders use the 60-minute chart and confirm with the daily chart. Below we provide some examples of confirmation.

Here is one of our covered call trades. The 12.50 call was written for a $0.40 premium on January 6, 2004 when the stock was at $12.65. Looking first at the daily chart below, we saw that AEM is well above both its 14- and 50-day moving averages (MA). The 14-MA recently crossed above the 50-MA, generally a bullish sign. AEM also had strong support at about $12.11 (a former resistance level now converted to support) and more support at $11, thus we felt pretty safe in getting only a $0.40 premium. Since this trade was written with 10 days left before expiration, it was a short-term trade. And viewing the following daily chart, we were optimistic about AEM's short-term prospects.

It is many times also helpful to look at a chart with a different time period, as the following AEM weekly chart illustrates. We do not trade from weekly charts, but they can be helpful to illustrate longer term trends when that information is necessary. At a glance on a daily chart, AEM appears to be in a downtrend since early September, but that is not the case as the weekly chart reveals: AEM is instead in a long-term trading range. The following AEM weekly chart clearly shows that AEM was in an 18-month uptrend through all of 2001 and much of 2002, when the overall market was not doing well. And it shows that AEM then went into a long-term trading range for approximately 18 months, where it remains today.

The above chart demonstrates that the long-term trading range actually is diminishing. You will note that the price advances on each wave of the range keep getting smaller, even though the lower bounds of the range haven't changed. That is, there is a clear downtrend since June 2002 in the upper boundary prices of the range, but the bottom of the trading range has not really changed, which creates what chart technicians call a "descending triangle" - a bad formation, since it suggests that the trading range will continue to tighten back to the lower bound of the range and then break below the range. Ouch. Thus while we like AEM short term as a covered call play, it is not one we would want on a horizon of longer than a few weeks. But we could not have gotten this perspective from a daily or shorter chart.

To confirm price action it is very helpful to view an hour chart for a different perspective. The 60-min. chart below indicates that AEM has been in an uptrend since right before Christmas and shows AEM well above both the 14-MA and 50-MA. If AEM was breaking below the 50-MA on the 60-minute chart, it is almost a sure bet that it would break below the 50 before long on a daily chart, so the 60-minute chart provides some early warning. Thus AEM is showing strength on both the daily and the 60-min. charts, which confirms its viability for a trade.

On the following daily chart, ANDW clearly went into a downtrend in mid-September, as the trendline indicates. Price held the 50-day moving average at Point 1, but drove beneath the 50-MA at Point 2 in November and only crossed back above it at Point 3 in January. We don't like stocks below their 50-MA and, based solely on a daily chart, would not have touched this stock for a covered call during the period of Point 2 to Point 3.

Now look at a 60-min. ANDW chart and, surprise, we see something different. Notice how price falls below the 50-hour moving average (50-MA) at Point 1 and then climbed back above the 50-MA at Point 2 on December 12th. Better yet, price tested the 50-MA repeatedly at Points 3, 4, 5, 6 and 7, holding the 50-MA on each occasion, which is a sign of strength. Yet on the daily chart the price continued below the 50-MA all through December and only crossed back above the 50-MA in January.

Which of the two charts do you believe? Actually they're telling you the same thing, just on different time frames. The 60-min. chart simply is more reactive to recent prices than the daily chart, so the 60-min. chart showed you that ANDW was recovering by December 12th and was a good covered call candidate - long before the daily chart showed you that only in January. Looking solely at a daily chart in December, you would have missed this trade based on the 50-MA. But the 60-min. chart would have gotten you into a good trade. Sometimes it works the other way, too, meaning that a trade will look bad on the 60-min. chart but has turned good on the daily chart. Better if they both agree, but that does not always happen.

What are the limits of the 60-min. charts? Don't count on them for more than about four weeks, tops. That is, if when you are making a trading decision you will be in the trade for more than four weeks, you're getting a little further out than the 60-min. chart can be expected to predict. We prefer to use the 60-min. chart for trades that have an expiration no more than three weeks out, although each trader has to experiment to see what configuration works for him.

Ways to Try CallWriter Try CallWriter for 10 days without risk - absolutely free! You'll have full access to our membership site! A $27.00 value Details Buy one month of CallWriter membership and get the second month free! $79.95 Save $79.95 Details Buy John's Ultimate Covered Call Book now and get two full months of CallWriter membership. $139.95 Save $119.90 Details Contribute an Article To contribute an article to the Money NewsLetter, send your contribution, along with your promotional byline, to: newsletter@callwriter.com. We don't pay contributors, but we will include your byline and a link to your website. Reproduction Don't hesitate to print out this newsletter for your own use or forward a copy of it to your friends and associates (we want you to), but please ask permission before reproducing the content in any form -- we would like to know who you are and how you are using it. Disclaimer We are not brokers, investment advisers or securities analysts and do not recommend the purchase, sale or holding of any security. Your use of any information or strategy appearing in this newsletter or on CallWriter.com is solely at your own risk. We urge our newsletter subscribers and CallWriter.com website members to do all requisite and analysis and properly plan each trade prior to making the trade and to manage each trade effectively. Covered call and other potential trades discussed in this newsletter or on CallWriter.com do not constitute trading recommendations by CallWriter or any other person and are presented by solely for informational and educational purposes.