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.

CallWriter's MADI

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 Compared to the Market

Analyzing the MADI

Other Considerations

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.

Declining Markets

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.

Wrapping Up

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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