Technical analysis is an integral component of our BCI methodology for covered call writing. When identifying stocks for our watch lists and portfolios, we look for uptrending price patterns and utilize moving averages to confirm these trends. In an ideal situation the price bars (OHLC) bounce off and above the short-term (20-day) exponential moving average. When this occurs, the moving average is serving as support for the price of the stock. In the inverse situation where the price is trading below the moving average and bouncing off and under this average, the 20-d ema is serving as resistance for the equity price. Here are the more formal definitions:
A price level at which there is sufficient demand for a stock to cause a halt in a downward trend and turn the trend up. Support levels indicate the price at which most investors feel that the prices will move higher. The figure below depicts a chart for support where the stock price turns up at the arrows:
The price level at which there is a large enough supply of stock available to cause a halt in the upward trend and turn the trend down. Resistance levels indicate the price at which most investors feel that the prices will move lower. Below is a chart of resistance where the price turns down at the point of the arrows:
In our system of locating the greatest performing stocks in the greatest performing industries we search for price patterns in an uptrend. An uptrend is established when a security forms a series of higher highs and higher lows. Such a price chart is depicted below:
When these trends are identified in normal market conditions, out-of-the-money strikes can be sold and option premium + share appreciation will bring our monthly returns into the 3-4% range and higher. As they say on Wall Street, “The trend is your friend”.
In the chart below for STEC, we see an uptrending moving average which is serving as support for the price of this equity. Here is that chart:
The green circles demonstrate areas of support. Note that in early August (purple double-side arrow) the chart shows that the price of this stock had a large drop on high volume. The price temporarily dropped below the 20-d ema. This was the result of an earnings report and exemplifies why we avoid equities that are reporting earnings in a particular contract period. These reports can surprise in either direction resulting in extreme volatility and price movements. STEC reported earnings on August 4th and the market reacted negatively. Those who follow the BCI methodology would not have owned this stock at that particular time and would not have suffered any short-term losses.
EBAY: An example of support from our current Premium Watch List:
Here are some of the ways this information can put CASH in our pockets:
- Sell O-T-M strikes when we have identified an uptrending moving average in normal market conditions.
- Avoid equities in a downtrend.
- Avoid the stock or sell I-T-M strikes when stocks are trading sideways (consolidating) or not in any particular trend.
- If a stock breaks through support (moves down) on high volume, be prepared to execute an exit strategy.
- If a stock breaks through resistance (moves up) on high volume, consider this a major technical positive.
Moving averages are effective tools for identifying and confirming trends as well as support and resistance. This facilitates our trading system as it assists in making our buy-sell decisions. Since it is a lagging indicator, it is not predictive of change as let’s say the MACD is. But as was stated before, “the trend is your friend” and we want as many friends as possible when investing our hard-earned money. As with all technical tools, moving averages should not be used alone, but rather in conjunction with our other technical indicators.
I am truly humbled:
Thanks for making my first two books #s 1 and 2 on the subject of “covered calls” on Amazon.com with my latest book, Alan Ellman’s Encyclopedia for Covered Call Writing ranked # 5.
This week proved to be yet another week of mixed economic reports:
- The number of new single- family homes sold in July increased by 3.6% over the number sold in June, more than anticipated
- Home inventories declined to 4.6 months of supply, a record low stat
- Existing home sales rose by 2.3%, less than expected
- Looking at year-to-year housing stats we find sales up 10.4% and inventory down 23.8% with median sales price up 9.4% compared to July, 2011. This is quite encouraging
- Durable goods orders ( A leading indicator of industrial production and capital spending. Data fluctuate widely from month to month and are often subject to significant revision) came in at 4.2% in July ahead of the 2.4% forecast mainly due to sales in the transportation sector
- Minutes from the FOMC meeting on July 31st-August 1st indicated that the Fed is considering further monetary easing
For the week, the S&P 500 fell by 0.5% for a year-to-date return of 13.8%, including dividends.
IBD: Confirmed uptrend
BCI: Moderately bullish favoring out-of-the-money strikes approximately 3 to 2.
My team and I thank you for your participation in our BCI community,
Alan ([email protected])