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A
moving average (MA) is simply a line on a price chart
showing the stock's average price over time in relation
to price bars, with price variations smoothed to a single
line. Traders figured out long ago that the moving average
can be highly significant in all types of trading activity.
The purpose of this article is not to teach the use of
moving averages but to show how we have integrated them
into our Real Time Lists™ so that you can use them
(as we do) in analyzing trades on the lists.
Since there is no way to overlay moving
averages onto the Real Time Lists™, we instead chose
to represent the 14-day and 50-day moving averages as
numbers on the lists. We invented the MADI
(moving average directional indicator), an oscillator
signal expressed in percentage form that indicates how
far the current stock price is off the 14-day or 50-day
moving average. A MADI of “00” means that
the current price is flat compared to the moving average
and indicates sideways price movement. This does not mean
the price has remained flat during the entire measurement
period, and it could in fact have moved up or down during
the period. The “00” value means only that
the current price is approximately at the moving average.
Each MADI point roughly corresponds to
a 2% price movement. A value of "05" indicates
that the current price is 10% higher than the moving average,
and "-05" indicates that it is 10% lower. Values
outside of the +/-10 range indicate a fair degree of movement.
The 50-MA is far more significant than the 14-MA, because
the 14 is a bit too reactive and conveys less valuable
information. For example, a stock with a 50-MADI of -10
has dropped far below the 50-MA, and it really would not
matter to me what the 14-MADI is doing, because I would
not likely touch the stock. Conversely, if the 50-MADI
is strong, I would not necessarily be put off by a negative
14-MADI, unless it was greater than -05, because the stock
still is showing strength on the 50-day average.
The three moving averages that we use
primarily are the 14-day (14-MA), 50-day and 200-day.
There are many others, but these are commonly used. For
brevity, we only show the 14-MA and 50-MA on the Real
Time Lists™. A frequent question from our members
is how to cut the analysis time for evaluating potential
trades, and the MADI is a good tool for speeding analysis
without sacrificing due care. For readers who are not
CallWriter members, we provide a sample
list with one current covered call trade featured
that demonstrates the MADI.
MADI
is Up,
Market is Up |
|
Stock is moving with
its index, which is the norm for a stock that moves
with the market. This only tells you that the stock
is not weak, not that it is a good covered call candidate.
For a more detailed analysis of what the MADI is telling
you, see the following section. |
MADI
is Up,
Market is Down |
|
The stock is showing more, perhaps
significantly more, strength than the market. This
is a good sign and warrants further analysis. |
MADI
is Down,
Market is Down |
|
The stock is moving with its index,
which is the norm for a stock that moves with the
market. The bad news is that the stock is no stronger
than the market, and you can perhaps do better. |
MADI
is Down,
Market is Up |
|
The stock is weaker than the market,
not a good sign. While a deeply in-the-money call
on this stock might work, it would never be a very
compelling trade, since there will almost always be
better trades. |
| 14-MA
and 50-MA both are the same value |
|
Indicates the two moving
averages have converged and that a moving-average
crossover of the 14-MA above or below the 50-MA may
be imminent. Or it can simply mean that the stock
is in a narrow trading range. |
| 14-MA
and 50-MA both are 00 |
|
Generally indicates that the stock
is in a trading range or slight downtrend, with an
RSI of 55 or less. |
| 14-MA
is down,
50-MA is 00 or -01 |
|
The stock has pulled back recently
but at the moment is holding or at least testing
the 50-MA. This may indicate a negative crossover
in which the 14-MA is crossing below the 50-MA.
We typically do not write these
in a flat or rising market, since we want to see
a successful test of the 50-MA and a new advance
- that is, a bounce off the 50. |
14-MA
is up,
50-MA is down |
|
The stock has advanced recently but
has not moved up enough to rise above the 50-MA. I
want to see the stock move above the 50-MA in order
to be sure that the 50-MA will not act as a resistance
level. |
| Both
the 14-MA and 50-MA are up |
|
The stock is advancing, and the bigger
the numbers the stronger the advance. If the 50-MADI
is above 10, I would look carefully at the chart to
see if a pullback is in order. |
| Both
the 14-MA and 50-MA are down |
|
The stock has been selling off and
probably has an RSI of 40 or below. Unless it catches
support at the 100- or 200-MA and starts a new advance,
its decline can be expected to continue. This generally
indicates a stock to avoid in a flat or rising market. |
Moving averages are not the end-all of
trading. Other factors such as support and resistance
remain important. For example, I will not normally consider
writing a stock that is hitting or about to hit a meaningful
resistance level, because I expect a pullback. Similarly,
a stock with a negative 50-MADI might be finding support
at the 100- or 200-MA and be ready for a new advance,
in which case an out-of-the-money call may be in order.
Although it is conventional Wall Street
"wisdom" that one does not write covered calls
in a declining market, we have not found this to be true,
necessarily. What IS true is that you'd best not write
when the market is in a steep decline or collapsing. When
the market is in a more moderate decline, writing is not
especially hazardous if you are careful and disciplined.
How can this be? First,
when a strong stock is in a moderate decline, it is not
difficult to write it deeply in the money.
Second, not
all stocks decline in a down market. There are virtually
always stocks that are holding price or even advancing
in a market decline, just as there are doggy stocks in
a bull market. Strong stocks in a down market are a delightful
thing for covered writers.
The dynamics of using moving averages
change with market conditions. As an example, it is universally
believed that a covered call stock should be above its
200-MA, since it is a sign of weakness to be below it.
However, that is only true in flat or rising markets.
In a prolonged bear market, pretty much every stock might
be below the 200-MA, in which case it no longer acts as
a guideline. In such case, you can't use the 200-MA as
a reference except when a stock below the 200-MA breaks
above it. By the same token, in a bull market (or during
a bear rally in a down market), virtually every stock
might be above the 200-MA, in which case being above the
200-MA is not so much evidence of strength as being below
it is evidence of weakness. When the market has been declining,
the 50-MA becomes that much more important, and really
separates the stronger stocks from the weaker.
The
MADI cannot show you the stock's trading history, nor
will it indicate a technical pattern forming. The MADI
thus is not a primary trading signal, and its best use
is to indicate whether further evaluation of a trade candidate
is justified. For example, a MADI of 07:01
may indicate that a stock trading in a very flat range
has recently spiked up; or it may indicate that a stock
which has been down has recently surged and has only now
crossed the 50-MA. That is, the same combination of MADI
numbers do not always mean the same thing or indicate
the same technical picture.
If
uncertain what the MADI is telling you, simply pull up
a chart on the stock (which you can do instantly from
the Real Time Lists™) and check what you are seeing
against the MADI. With surprisingly little practice, you
will learn to picture the stock's recent price movement
from simply viewing the MADI, with a fair degree of accuracy.
Before
you even think about trading, know what the market is
doing. Look at daily charts on the Dow Jones Industrial
Averages, the S&P 500 Index and the Nasdaq Composite
Index and know what their charts look like. Without this
knowledge, the MADI - and moving averages in general -
have little meaning, since you cannot analyze a stock
in a vacuum. You must know what the stock's index is doing.

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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. |
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