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January 7, 2004
Confirming with Different
Chart Time Frames
By John Brasher, CallWriter Publisher
Chart technicians like
to talk about charts and chart patterns. Maddeningly, though,
they frequently forget to talk about what sort of time frames
to use on charts and whether to use more than one time frame
when reviewing a potential covered call trade candidate. This
article will provide some insight into chart time frames and
into confirming what the chart is telling you.
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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.
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