Wiser Trader Stocks and Options Newsletter

Issue No. 7 – January 3, 2005

http://www.WiserTrader.com

Systems@WiserTrader.com

James A. Andrews

 

1.0 Trading Time Frame

 

      This week’s discussion is on determining the trading time frame for a given option and adjusting technical indicators accordingly.  Having an informed idea of the trading time frame helps one decide the proper level of vigilance.  Not all technical indicator set ups are appropriate for every trading time frame.  Some set ups are overly sensitive, giving too many false signals, while others are not sensitive enough, leading to missing a trade entirely or losing profits previously gained.  The trading time frame is based on the price behavior of the underlying stock and the exaggerated behavior of an oscillator, such as the Slow Stochastic or the Williams %R.  Once the time frame has been established, one can adjust the sensitivity of simple moving averages (SMA) by selecting the appropriate number of periods used in their calculation.  This solution lies in the larger context of a TTC trading template, one of many developed by Dr. Stephen Cooper at beststocktradesecrets.com.  The TTC stands for trend, trigger and confirmation.  The discussion begins with an overview of this component of Dr. Cooper’s trading system followed by an example of how it can be applied to one of the stocks in our watch list.

 

      As many readers are already aware, the short term options watch list is composed of optionable stocks whose percentage relative strength over the past 6 months is greater than 90%, EPS Growth over the past 12 months is greater than 80% and are within 5% of their 52 week high with a minimum price of $50.  While these features in themselves imply an up trend, more objective measures of an uptrend can be found in an upward slope of a stock’s 30 day moving price average and confirmed with both the fast and slow MACD lines being consistently above the zero reference.  A modest up trend has been in place since December 7^th for Oregon Steel (NYSE:OS) in the daily price chart of Figure 1.  A trigger indication is shown in the Slow Stochastic (below 20) and Williams %R (below -80) charts around December 16^th.   A trade entry confirmation came in the form of the price closing above the 7 day moving average on December 17^th in the top chart. 

 

      Before we go much farther, let’s assume that we only trade with a trend, either up or down, and are not attempting to trade against the trend.  Second, let’s agree that the trend for the stock of interest is in the same direction as trends for the major indices (DOW Jones Industrials, S&P500 and NASDAQ).  Third, although not a strict timing feature, let’s agree that we are committing no more than from 4% to 10% of our capital in the trade.  Fourth, we exit the trade when the price drops 25% from the maximum price reached after trade entry.  This will limit our maximum loss to from 1% to 2.5%, respectively of our capital on any given trade.  The lower these numbers, the more objective we will tend to be.

 

      Having received a trigger to enter a trade, the question arises concerning how long this trade would be expected to last.  To determine this we look back at the historic rise and fall of the Williams %R oscillator during previous up trends.  Over the past six months, the oscillation period from over sold to over bought ranges from two weeks to about one month.  This is an estimate of the trading time frame. 

 

      The most basic moving average is the n period simple moving average (SMA).  The n period SMA is plotted by adding closing prices for the previous n periods and dividing by n.  The length of a period and the value of n and are intimately connected with the trading time frame.  The length of a period can be minutes, hours, days, weeks or months.  For this discussion we are focused on a period of one day.  The upper chart in Figure 1 uses a 30 day SMA and a 7 day SMA.  It is no accident that these two time periods differ by about a factor of four.  The seven day SMA is about half the two week lower time frame estimate and the 30 day SMA is about one and a half times the four week upper time frame estimate.  Remember that 30 trading days is six weeks.  These settings are appropriate.  Namely, the fast and slow SMA’s should bracket the lower and upper time frame estimates.  The slow (30 day) SMA should be about four times the period of the fast (7 day) SMA.  Had our time frame estimates shifted in either direction by a factor of two, the period n for each SMA would be shifted by the same factor. 

 

      Practically speaking, there are not many free charting tools that will let you easily adjust the time period that technical indicators are based on.  The unusual charting tool used here is totally flexible in that respect and relatively low cost.  Its name is XLQ and it was created to operate as a platform for bringing an unlimited number of current and historical stock price quotes into Microsoft Excel either in real time, if you have such a subscription, or with the normal 20 minute delay without a subscription.  Then normal Excel plotting capabilities can be used to generate the charts in Figure 1.  The software can be obtained for under $100 from Leo van Rijswijk at http://www.qmatix.com.  Leo’s email is leov@QMatix.com.  There is a users group also.  We have no affiliation, as yet.  Maybe some day – Sigh!  He gives such excellent customer support.  XLQ was recommended to me by Brian Hunt, editor of the MicroCap Moonshots Newsletter.

 

      A word about trading templates is in order.  Some of the characteristics of a good trading system are that it must be simple and easy to use, take little of your time and give clear trading signals.  In addition to the stock price chart, the TTC template uses the 30 day SMA to determine trend, the Williams %R for the trigger and the 7 day SMA for confirmation.  That’s it!  All the other information in Figure 1 is superfluous to that template.  The more indicators one piles on to the decision making process, the more likely he will become paralyzed by information overload.  This can be very costly.  Different groups of indicators comprise different templates for various market conditions.  Keep it simple, I keep telling myself.

 

 

 

FIGURE 1

 

 

 

2.0 Analysis

 

      The industry leaders list contains the top 10 industries for four periods consisting of 1 week, 1 month, 2 months and 3 months.  Results are ranked highest to lowest based on the average percentage gain per week within any period times the number of appearances of an industry in the four top 10 lists.

 

 Market Summary

 Week ending 01/01/05:

 Indices for the Week:

 Dow Jones     -0.4%

 NASDAQ 100    +0.7%

 S&P500 Index  +0.1%

 Russel 2000   +0.3%

 Industry Leaders:

 Home Construction

 Tires

 Toys

 Mining

 Tobacco

 Healthcare Providers

 Coal

 Pipelines

 Lodging

 Airlines

 Steel

 Heavy Machinery

 Real Estate

 Office Equipment

 Cyclical Goods & Services

 Medical Supplies

 Travel & Tourism

 Water Utilities

 Retailers Specialty

 Clothing & Fabrics

 Mortgage Finance

 Industrial Suppliers

 Auto Parts

 Gold for past 30 days:

 USD    -3.08%

 CAD    -1.84%

 CHF    -3.67%

 GBP    -3.86%

 EUR    -5.64%

 JPY    -3.11%

 

 

 

      The five week RSI for the major indices is still very over bought.  From the sentiment indicators below, traders still remain bullish, optimistic and complacent.

Table 1

Sentiment Indicators

 

                       

 

3.0 Procedure

 

      The following stock screens were generated with tools from AAII.  The short term trading screen used for Table 2a looks for optionable stocks whose percentage relative strength over the past 6 months is greater than 90%, EPS Growth over the past 12 months is greater than 80% and are within 5% of their 52 week high and a minimum price of $50.  Commercial Metals Company (NYSE: CMC) turned up as a new short term candidate.  However, the recent gap up could indicate it is either nearing the end of an up trend or beginning a new one.

 

 

 

Table 2a

Short Term Options Screen as of   01/01/05

 

 

 

 

 

      The stock screen in Table 2b was added for the potential to write covered call options.  The only difference between screens for Tables 2a and 2b are that in 2b the maximum stock price is $20.  Ixia (NASDAQ: XXIA) was added to the list this week.

 

 

 

 

Table 2b

Short Term Covered Call Writing Screen as of   01/01/05

 

 

 

 

      For the screen, Mine Safety Appliances (NYSE: MSA) was added.  The number of selections for this screen is reduced by eliminating stocks having P/E’s greater than 30.

 

 

 

Table 2c

Modified Growth Momentum (Intermediate Term) Screen as of   01/01/05

 

 

 

 

 

      For the Peter Lynch screen, Korea Electric Power (NYSE: KEP) was added.  Again, the number of selections for this screen is reduced by eliminating stocks having P/E’s greater than 30.

 

 

 

 

 

 

 

Table 2d

Peter Lynch Value  (Intermediate Term) Screen as of   01/01/05

 

 

 

      A screen for Warren Buffet style stock picking was added for the intermediate to long term.  Two requirements were added to include only optionable stocks in order to find LEAPS opportunities.  Seven out of the 11 stocks had LEAPS written for them.  The other requirement was to include only those stocks having a PE of 17 or less.  Although some near term options are listed, they should be viewed with caution.  The Buffett screen does not include momentum stocks.  These are considered value stocks due to their PEG’s in the range of 1 to 1.7.  They would not be expected to move quickly.  No new stocks showed up in the screening process this week.  This is rather appropriate for a longer term screen.

 

 

 

Table 2e

Warren Buffett Value  (Long Term) Screen as of   01/01/05

 

 

 

 

4.0 Results

 

      Two long stock positions, OS and AKS, were entered from the list of covered call candidates.

 

 

Table 3

Stock Trades as of  01/01/05

 

 

Table 4

Option Trades as of 01/01/05