Wiser Trader Stocks and Options Newsletter

Issue No. 8 – January 10, 2005

http://www.WiserTrader.com

Systems@WiserTrader.com

James A. Andrews

 

1.0 Williams %R

 

      The recent pull back in the markets is consistent with recent sentiment indicators that traders remain bullish, optimistic and complacent.  The big three indices, Dow Jones Industrials, NASDAQ and S&P 500, are all oversold with their 30 day simple moving averages (SMA) flat.  What direction will the market take from here?  We don’t know.  The Stephen Cooper Trading System we use does not attempt to predict market direction, as such.  Dr Cooper reminds us that when using his system we are observers of market direction and trend followers.  We make money in both up and down markets.  When money flows into the market, we buy stocks with the greatest inflow.  When money flows out of the market, these same stocks tend to have the greatest out flow.   It doesn’t really matter to us what direction the markets take, as long as the direction is clear. 

 

      When markets and individual stocks are indecisive it’s time to keep our powder dry and polish our tools.  The Williams %R is an important tool we use to trigger a trade.   This is a good time to map out its details of composition based on a discussion found at stockcharts.com.  Developed by Larry Williams, the Williams %R is a momentum indicator. It is especially popular for measuring overbought and oversold levels. The scale ranges from 0 to -100 with readings from 0 to -20 considered overbought, and readings from -80 to -100 considered oversold.

 

      Overbought is a technical condition that occurs when prices are considered too high and susceptible to a decline. Overbought conditions can be classified by analyzing the chart pattern or with indicators such as the Stochastic Oscillator and Relative Strength Index (RSI). A  security is sometimes considered overbought when the Stochastic Oscillator exceeds 80 and when the Relative Strength Index (RSI) exceeds 70. It is important to keep in mind that overbought is not necessarily the same as being bearish. It merely infers that the stock has risen too far too fast and might be due for a pullback. 

 

      Oversold is a technical condition that occurs when prices are considered too low and ripe for a rally. Oversold conditions can be classified by analyzing the chart pattern or with indicators such as the Stochastic Oscillator and Relative Strength Index (RSI). A security is sometimes considered oversold when the Stochastic Oscillator is less than 20 and when the Relative Strength Index (RSI) is less than 30. It is important to keep in mind that oversold is not necessarily the same as being bullish.  It merely infers that the security has fallen too far too fast and may be due for a reaction rally.

 

 

      The Williams %R, sometimes referred to as %R, shows the relationship of the latest closing price relative to the high-low range over a set period of time. The nearer the closing price is to the top of the range, the nearer to zero, the higher the indicator will be. The nearer the closing price is to the bottom of the range, the nearer to -100, the lower the indicator will be. If the last closing price equals the high of the high-low range, then the indicator will show 0 (the highest reading). If the last closing price equals the low of the high-low range, then the result will be -100 (the lowest reading).  The Williams %R is calculated by,

 

 

      Typically, the Williams %R is calculated using 14 periods (n = 14) and can be used on intraday, daily, weekly or monthly data. The system used in this newsletter typically applies to daily data.  The timeframe and number of periods will likely vary according to desired sensitivity and the characteristics of the individual security, as discussed last week. 

 

      It is important to remember that overbought does not necessarily imply time to sell and oversold does not necessarily imply time to buy. A security can be in a downtrend, become oversold and remain oversold as the price continues to trend lower. Once a security becomes overbought or oversold, traders should wait for a confirming signal that a price reversal has occurred. One method might be to wait for the Williams %R to cross above or below -50 for confirmation. Price reversal confirmation can also be accomplished by using other indicators or aspects of technical analysis in conjunction with the Williams %R.  The confirmation signal used in this newsletter is when the closing stock price crosses its 7 day SMA. 

 

      One method of using the Williams %R is to identify the underlying trend and then look for trading opportunities in the direction of the trend. In an uptrend, traders look to oversold readings to establish long positions. In a downtrend, traders may look to overbought readings to establish short positions. 

 

      Everyone is familiar with Dr Cooper’s TTC-A trading template from the discussion last week.  The template uses 3 technical indicators to enter a stock or options trade.  TTC-A is an acronym for trend, trigger and confirmation.  The A at the end is just a name to distinguish this template from others, B, C and so on.  I like to use the A as a reminder that one needs to “affirm” that the overall markets are moving in the proper direction just before a trade is entered.  A positive or negative slope of the 30 day SMA is used to determine a, respective, up or down trend (T).  The over sold (less than -80%) or over bought (greater than -20%) condition of the Williams %R indicator is considered a trigger to trade (TT).  Confirmation comes when the stock price closes above its 7 day SMA for a long trade or below its 7 day SMA for a short trade (TTC).  The affirmation comes the following day in that the overall market, as well as, the price of the stock of interest, must be moving in the intended direction of trade (TTC-A).  One of the things that make this strategy so powerful is a strong watch list.   A strong watch list provides a target rich environment and keeps us from chasing after the latest “hot stock tip”.

 

 

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.  This week’s list is short as most industries were down for the week.

 

 Market Summary

 Week ending 01/08/05:

 Indices for the Week:

 Dow Jones     -1.7%

 NASDAQ        -4.0%

 S&P500 Index  -2.1%

 Russell 2000  -5.9%

 Industry Leaders:

 Home Construction

 Tires

 Tobacco

 Healthcare Providers

 Toys

 Lodging

 Mining

 Retailers, Drug Based

 Casinos

 Real Estate

 Computers

 Pipelines

 Insurance, Full Line

 Medical Supplies

 Non-life Insurance

 Gold for past 30 days:

 USD    -5.98%

 CAD    -4.03%

 CHF    -3.35%

 GBP    -3.07%

 EUR    -4.80%

 JPY    -4.92%

 

      The five week RSI for the major indices are neutral.  Their 5 day RSI are oversold.  From the sentiment indicators in Table 1, traders 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.   This week’s screening turned up Apple Computer with CLF and MGG being from previous weeks.  It is noteworthy that these three stocks were the only ones to show up in this week’s short term option screen.  Depending on market direction, both calls and puts were listed.

 

Table 2a

Short Term Options Screen as of   01/08/05

 

 

      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.  Nothing showed up for the covered call writing this week.  These are the same stocks from previous weeks with January options replaced by February expirations.

 

Table 2b

Short Term Covered Call Writing Screen as of   01/08/05

 

 

      For the screen in Table 2c, the number of selections is reduced by eliminating stocks having P/E’s greater than 30.  KBH resulted from the screen this week.

 

 

 

Table 2c

Growth Momentum (Intermediate Term) Screen as of   01/08/05

 

 

 

 

 

      For the Peter Lynch screen in Table 2d, 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.  FMST, NOLD, MBT and MEDQ  are new candidates from the lynch screen this week.

 

 

Table 2d

Peter Lynch Value  (Intermediate Term) Screen as of   01/08/05

 

 

 

      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.  The other requirement was to include only those stocks having a PE of 17 or less.   Four new candidates, ACS, COLM, HELE and THO resulted from this week’s screening.

 

 

 

Table 2e

Warren Buffett Value  (Long Term) Screen as of   01/08/05

 

 

 

 

      A screen was added for Benjamin Graham’s style of utility investing in Table 2f.  A summary of his screening method can be found at the sit in the watch list section.

 

 

Table 2f

Benjamin Graham Value (Long Term) Screen as of   01/08/05