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Daily Newsletter, Wednesday, 03/08/2006

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

A Tale of Two Day's Trading in One

Negative influences abounded in the pre-market period today, with bourses tumbling across the globe, OPEC meeting, and Google (GOOG) goofing up again. FOMC members Bernanke and Poole were slated to speak and markets might have felt some hesitation ahead of their speeches, especially in a rising-interest-rate environment. Iran was doing some saber-waving, warning the U.S. to expect "harm and pain" if the UN Security Council takes action against the country, and asserting that it will continue its research no matter what the UNSC says. The U.S.'s ambassador to the IAEA did some saber-waving of his own, saying that Iran's nuclear defiance should result in consequences to the country. North Korea had reportedly fired two missiles near China's border.

Although few were watching, Treasury Secretary John Snow also fired a missile this week. The WASHINGTON POST was watching, however, and an article today discussed the development. In a letter to Congress, Snow announced his intention to begin drawing from the Civil Service Retirement and Disability Fund to avoid reaching the statutory debt national debt limit. The money will be repaid, with interest, once Congress raises the debt limit, Snow asserted. Last month, a decision temporarily stopped investments in the retirement savings plans of government employees. Snow urged members of Congress to raise the limit immediately, saying that the steps taken last month and this week will keep the government from hitting the debt limit until mid-March.

All those influences were to weigh on the markets and send them sharply lower again, but then the bulls started scaling those walls of worry. Most daily candles left a long candle shadow springing up from support. Some say that the move of the ten-year yield back above that of the two-year treasury note's yield helped or prompted the bounce, although the inversion remains among other treasury bonds. Whether that spring higher in the equities will be strong enough to vault the indices over support-turned-resistance remains to be seen.

I'd had a two-day scenario in mind for the indices that included a punch lower today and then a steadying, to be followed by either choppy movement higher or an actual bounce tomorrow toward those support-turned-resistance levels. I'd had trouble reconciling that scenario for tomorrow with a historical selling bias for the day, to be discussed later. The indices confounded my two-day scenario by splitting the morning and afternoon sessions into two day's worth of action, accomplishing this afternoon what I'd anticipated for tomorrow's action, a bounce up to next resistance. That sets up the potential for a rollover tomorrow now that the bounce up to resistance has been accomplished, but let's see what charts show.

Annotated Weekly Chart of the SPX:

The close above the 50- and 30-sma's was not a particularly convincing one. If the SPX pushes higher tomorrow, watch for signs that 1281-1283.50 resistance is holding. A break above that would see next resistance at the 10-sma. If it were not for the persistent bid under the markets, I'd suggest more strongly that bearish entries be sought on any hint of hesitation after a bounce or on any hint of a rollover from the current level, but that bid may persist. Care still needs to be exercised. My strongest guess is for continued chop, perhaps for another day ahead of Friday's economic numbers, between today's resistance and today's support, so if a rollover materializes, protect positions near today's low.

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

As mentioned in the introduction, many influences combined to produce the market action today, many of those influences being negative. Early morning commentary focused on the OPEC meeting and Google's (GOOG) goof in accidentally releasing sales guidance. That sales guidance shows 2006 advertising income in line with expectations. Goldman Sachs promptly lowered its price target to $490 from its previous $500, eliciting some ribbing from CNBC commentators about the precision with which GS thought it could project price targets. Other negative influences in early trading included a disappointment from Dynegy (DYN) after the company's loss from continuing operations was wider than expected.

Keene spent some time last night in his Wrap discussing the housing industry, showing charts of the DJUSHB, the Dow Jones Home Construction Index. This morning brought more news relating to the housing industry. The Mortgage Bankers Association released mortgage applications for the week ending March 3. The title of the release again noted that the volume held steady. The component measuring mortgage loan application volume increased 0.7 percent from the previous week on a seasonally adjusted basis, but declined 17.8 percent from the year-ago level on an unadjusted basis. Compared to the previous week, the Purchase Index rose 0.4 percent; the Refinance Index, 2.6 percent; the Conventional Index, 0.3 percent, and the Government Index, 5.7 percent. Four-week moving averages were still moving down, however, by 1.9 percent for the Market Index, 1.6 percent for the Purchase Index and 2.1 percent for the Refinance Index. Interest rates for a 30-year fixed-rate mortgage rose to 6.31 percent and points increased.

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Early in the day, St. Louis Fed President Poole spoke concerning housing. No major slowdown is expected, he said, although he conceded an expectation that average home price increases would slow. Consumer spending is more dependent on income and job growth than on housing increases, he feels. He believes that it's the Fed's intention to keep inflation stable at a low level and real household income will likely rebound after being hit by energy prices last year. Perhaps his reassurances worked or perhaps the embattled DJUSHB was due for an oversold bounce, but it was one of the first indices that attempted to bounce from its low although that first attempt did not hold. FOMC head Bernanke also spoke, but his topic--banking--perhaps did not engage market watchers as much and his speech appeared to have little impact on the markets. He was not slated to talk about interest rates.

Interviewed as he was headed into the OPEC meeting, the minister from Kuwait said that he expected crude prices to dip below $60.00 in the second quarter, a prediction that was to come true sooner than he might have expected. He qualified that statement, however, by noting that although demand typically drops in the second quarter, India and China had skewed the usual patterns, and it was now more difficult to predict demand and plan production needs. He expects demand to increase this year, but said that non-OPEC members can keep up with the increased demand.

Crude traded lower in the pre-market period, a forecast of its trading pattern for the day, when it was to reach a low of $59.25 before bouncing strongly from and closing at $60.02. OPEC was to issue the hoped-for decision not to cut production, citing geopolitical uncertainties as one reason to maintain production at current levels.

Exxon Mobil's (XOM) chairman and Chief Executive Rex Tillerson weighed in today on the issue of energy independence. He claims that the government is misleading the public when it talks of becoming energy-independent. That's not possible, he claims, using his time in the spotlight to urge for more development of domestic resources. He said the government is withholding those resources--in the Rocky Mountains, the eastern Gulf of Mexico, offshore California and the Arctic National Wildlife Refuge--from the people. [Note: This is a reporting of developments today, and not an endorsement of these ideas.] Tillerson believes energy prices will settle lower, an outlook to be disputed by an analyst speaking today, with his comments noted later in the Wrap.

Most market watchers surveyed believed that crude inventories would rise and gasoline and distillate inventories would fall. According to one forex news source, estimates were for a rise of 1.6 million barrels in crude inventories and declines of 250,000-600,000 in gasoline inventories and 1.6 million barrels on distillates.

Crude inventories numbers surprised when they were released at 10:30 EST. Crude inventories soared 6.8 million barrels for the week, leading the Energy Department to note that the inventories levels are at their highest since May 1999. Gasoline and distillate inventories fell more than expected, however, by 1.1 million barrels and 2.7 million barrels, respectively. Those surprises were moderate when compared to the upside surprise in crude inventories, and the focus remained on the build in crude stocks.

"Cloudy" was what an analyst with Societe Generale was to term that unexpected build in crude inventories when he spoke on CNBC immediately after the release. He noted the changeability of these figures based on constant updates from refineries on what units were being shut down or brought on line again. He commented that the crude story is not over, that the story might not develop until the second half of the year, but that he expected crude to average in the mid-$60's for the year.

Cloudy numbers or not, crude prices dove, as already noted. Other commodity prices saw sharp declines, too.

Not to be ignored today was the NYSE's debut as a publicly traded company under the ticker symbol NYX. Early in the day, some had speculated that the powers-that-be might prop up markets on the day of such an important IPO. The IPO did perform well, opening at $67.00 and closing at $80.31, and perhaps its strong performance also contributed to enthusiasm that led to an afternoon bounce, but I suspect that oversold conditions had more to do with that.

After-hours development include a jump in Biogen Idec, Inc.'s (BIIB) value when it opened for trading after the FDA approved the return of its MS drug Tysabri. As this report went to press, TiVo (TIVO) had also just reported and was rising in after-hours trading after it had narrowed its fourth-quarter loss from the year-ago level.

Tomorrow's economic reports include initial claims and January's Trade Balance at 8:30, and then the natural gas inventories at 10:30. Reporting companies will include ARO, BBI, CTIC, CLE, ISIS, and RMX. A number of those are retailers, and many other retailers, not included in the list, are reporting, too.

An interesting article on seasonal stock patterns was printed in the February 2006 issue of STOCKS & COMMODITIES. That article's author, Robert Steelman, noted that the ninth calendar day of each month tended to have a sell bias. Jim Brown has been noting some seasonal trading patterns with regard to March, too.

As mentioned earlier, I was having trouble fitting that seasonal pattern for tomorrow into what I thought still needed to happen: a bounce back to retest broken support. Since that bounce occurred this afternoon instead, it provides leeway for the seasonal pattern to assert itself and for markets to turn down tomorrow. It provides leeway, but not proof.

My best-guess scenario is for perhaps another day of trading in the ranges established over the last couple of days of trading. The fact that defensive-type stocks appeared to lead the recovery reinforces the idea that resistance might hold. However, my expectation that the recent ranges may hold for another day means that if there are downturns tomorrow, profits need to be protected near the bottoms of those ranges.

I'm always aware of that underlying bid in the markets, however. It's been there since March, 2003, and despite the fact that the TRAN and the SOX show classic topping-out behaviors and that both saw steep declines this week, neither has seen irreparable damage done to their charts. Don't hold onto a losing bearish position if markets appear to roll over and then shoot higher.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None None None

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cigna - CI - close: 125.60 change: +2.10 stop: 121.90 *new*

We continued to be somewhat surprised by CI's sudden show of strength but then again healthcare stocks tend to be seen as defensive in nature. CI displayed some relative strength today and broke out to new five-year highs. Volume was just above average on the session. Technical indicators are turning positive and the move over $125.00 looks like a new bullish entry point. Our target is the $129.75-130.00 range. We are going to raise our stop loss to $121.90 since the $122.00 level held as support for the last week.

Picked on February 26 at $124.57
Change since picked: + 1.03
Earnings Date 02/08/06 (confirmed)
Average Daily Volume = 944 thousand

---

Garmin Ltd. - GRMN - cls: 74.78 change: +0.94 stop: 69.75 *new*

GRMN continues to look strong. The stock rebounded higher today adding 1.27%. The stock looks poised to make another run toward our target in the $77.00-78.00 range. After the closing bell today GRMN issued six press releases regarding new deals, new partnerships and new features. We are going to raise our stop loss to $69.75.

Picked on March 02 at $ 72.70
Change since picked: + 2.08
Earnings Date 02/22/06 (confirmed)
Average Daily Volume = 1.2 million

---

Hartford Fin. Srv. - HIG - cls: 81.70 chg: +0.09 stop: 79.95

We have nothing new to report on for HIG. We're not suggesting new positions. The path of least resistance appears to be down toward the support near $80.00 and its 200-dma.

Picked on February 14 at $ 82.12
Change since picked: - 0.42
Earnings Date 01/26/06 (confirmed)
Average Daily Volume = 1.1 million

---

Altria Group - MO - close: 72.65 chg: +0.86 stop: 71.85

Heads up! Defensive stocks were on the move today and tobacco tends to be seen as a defensive play. Shares of MO are beginning to bounce from technical support at its 200-dma. Aggressive traders might want to seriously consider new positions here. The short-term technical oscillators are certainly looking more bullish. We are going to wait before suggesting new plays. We still see technical resistance at the 50-dma near $73.70 and price resistance near $74.00. Our plan suggests a trigger to buy calls at $74.11. If triggered we'll target a rally into the $77.50-78.00 range.

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/19/06 (unconfirmed)
Average Daily Volume = 8.1 million

---

Ultra Petrol. - UPL - close: 52.68 change: +1.68 stop: 51.95

UPL is bouncing from its lows near support at the $50.00 level but the stock hasn't broken its trend of lower highs yet. We are still on the sidelines. We are suggesting a trigger to buy calls at $55.05. If triggered then we will target a quick rebound into the $59.50-60.00 range, which is under resistance at the 50-dma. More aggressive traders may want to use a wider stop loss.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/09/06 (unconfirmed)
Average Daily Volume = 1.7 million

---

Valero Energy - VLO - close: 53.79 change: +0.15 stop: 53.49


VLO is also bouncing from its lows of the session but the stock remains under resistance near $57.00-57.50. We're suggesting a trigger to buy calls at $57.55. If triggered we'll target a move into the $62.50-63.00 range.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/02/06 (unconfirmed)
Average Daily Volume = million
 

Put Updates

Apple Computer - AAPL - cls: 65.66 change: -0.65 stop: 70.11

There was no follow through on yesterday's bounce in AAPL and that's a good thing for the bears. We don't see any changes from our previous updates. Our target is the $63.00-62.00 range, which should line up with the small head-and-shoulder pattern projection. More aggressive traders might want to aim lower like $60.

Picked on March 05 at $ 67.72
Change since picked: - 2.06
Earnings Date 04/19/06 (unconfirmed)
Average Daily Volume = million

---

Intl. Bus. Mach. - IBM - cls: 81.14 chg: +0.85 stop: 81.05

The posture on IBM is changing. The stock is trying to breakout to the upside from its sideways to down consolidation. Today saw the stock rally toward technical resistance near its 50-dma and 200-dma. We're still on the sidelines but if IBM trades over $82.00 traders might want to consider going long calls on the stock. Right now our plan involves a trigger at $78.89 to buy puts.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/18/06 (unconfirmed)
Average Daily Volume = 6.2 million

---

KB Home - KBH - close: 63.35 chg: +0.78 stop: 68.05

Homebuilders managed a somewhat tepid oversold bounce today. Shares of KBH could rebound to $65.00 or even the 10-dma near 66.32 and still not break its bearish pattern. We are not suggesting new bearish positions at this time. Our target is the $60.50-60.00 range.

Picked on March 06 at $ 64.75
Change since picked: - 1.40
Earnings Date 03/22/06 (confirmed)
Average Daily Volume = 1.9 million
 

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

---

Building Materials - BMHC - cls: 65.57 chg: +0.40 stop: n/a

We are not suggesting new strangle positions at this time. Our target is at breakeven ($8.20). Keep an eye on the March $70 puts (BGU-ON). More conservative traders may want to think about exiting early to recoup some of their capital.

Picked on December 18 at $ 80.95
Change since picked: -15.38
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 527 thousand

---

Encana Corp. - ECA - close: 42.72 chg: +0.62 stop: n/a

We don't see any change from our previous updates. We are not suggesting new strangle positions. Our strangle strategy involves the April $50 calls (ECA-DJ) and the April $40 puts (ECA-PH). Our estimated cost is $3.45. We are aiming for a rise to $5.95.

Picked on January 10 at $ 45.56
Change since picked: - 2.84
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

---

Loews Corp. - LTR - close: 94.11 change: +1.06 stop: n/a

There is no change from our previous updates on LTR. We are not suggesting new strangle positions. Buying this strangle was a bet that LTR will be trading at more than $102 (above resistance) or less than $88 (under support) by March expiration. The options in our strangle are the March $100 calls (LTR-CT) and the March $90 puts (LTR-OR). Our estimated cost is $1.75.

Picked on February 13 at $ 95.72
Change since picked: - 1.61
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 513 thousand

---

Ryland Group - RYL - close: 66.46 change: +0.41 stop: n/a

We expected an oversold bounce in RYL and that's what the stock delivered today. The bounce may not be over yet. We are not suggesting new strangle positions at this time. Our play involves the April $80 calls (RYL-DP) and the April $70 puts (RYL-PN). Our estimated cost is $7.00. Our target is $12.00.

Picked on January 22 at $ 75.19
Change since picked: - 8.73
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

Monster Wrldwde - MNST - close: 46.17 chg: -1.45 stop: 47.75

Internet stocks are struggling thanks in part to weakness in GOOG. Shares of MNST lost another three percent today. We've been waiting for a breakout to a new high with a trigger at $50.65. We're now choosing to drop MNST as a bullish candidate. More aggressive traders might want to keep an eye on MNST for a bounce from the $45.00 level, where round-number support will be bolstered by its rising 50-dma. On the other hand if MNST breaks down under $45.00 it might be time to buy puts.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/03/06 (unconfirmed)
Average Daily Volume = 1.7 million

---

Occidental Petrol. - OXY - cls: 90.18 chg: -0.50 stop: 89.49

Oil stocks were somewhat volatile today as investors tried to juggle news from OPEC and the inventory numbers. OPEC decided to leave production quotas unchanged while inventory here in the U.S. came in much higher than expected. The oil sector rebounded from its lows as did shares of OXY but not before the stock hit our stop loss at $89.49. This loss would not have been so big if we had not been triggered on a gap higher back in February.

Picked on February 21 at $ 92.00 *gap higher*
Change since picked: - 1.82
Earnings Date 05/09/06 (unconfirmed)
Average Daily Volume = 3.4 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Moving Averages and 'Optimal' Settings For Trading

I got a question from one of our subscribers recently that asked me about the 'optimal' settings for moving averages. The short answer is that there are none in the sense that different moving average lengths (number of periods that are calculated) and types ('simple', 'exponential', etc.) are a matter of individual PREFERENCE. It's pretty subjective process a lot of the time. There is a more 'objective' determination for length setting involving 'optimization'.

#1. Preference and experience; i.e., what you have found best gauges the trend for the stocks and the indexes that you follow and given the TIME FRAME you like to follow and trade (short-term day to day, weekly, biweekly to monthly, etc). I will give you my take on what works well for moving averages as to type and length, that helps me make trading decisions for the short (2-3-5 days) to intermediate-term (2-3 weeks or a bit longer).

#2. There is something called optimization that can be employed in some trading applications to check a moving average trading strategy or trading 'system'. EXAMPLE: For a given time period (e.g., the last 5000 days), what single moving average would have produced the best 'net profit' had you bought or shorted each time a stock or an index closed above or below that (single) moving average.

More likely, as it's much more commonly used in making trading decisions, would be what set of TWO moving averages had the greatest net profit for a 'crossover' of the two; i.e., a moving average crossover trading strategy. For example, going long when a 10-day average crosses ABOVE the 20-day moving average; or, selling short when the shorter moving average crosses BELOW the longer moving average.

Optimization is the computer running a test to determine, for the history you have, what set of moving averages performed best for certain criteria; e.g., 'net profit'.

For example, I just ran a simple 'optimization' comparing the net profit (over the past 5000 trading days) for all SETS of Simple Moving Averages (SMA) from 5 to 13 as the shorter average, crossing above or below all longer moving average lengths from 21 to 55. And where I only bought when the shorter average crossed above a longer average; no shorting, in order to keep it simple.

I would also note that an optimization computation can also include a test of the optimal 'trailing' exit or stop-out point in case the trade lost money before there was another crossover 'signal', but was also not employed here in the example. The optimization procedure is usually done to determine the most profitable Trading Strategy or System by determining the total point gain; other computations can be done to account for commission costs, 'slippage', etc, in order to account for the real world of trading.

With options, there are more complications, but a rough rule of thumb is that optimizing for the greatest point gain for a set of moving averages (for crossovers) will give us a good set of moving averages with which to determine trend direction. This also assumes that the optimization process has been used for at least several years worth of past price history. There is always something you have to optimize 'FOR'; e.g. greatest point gain.

Results showing what set of two 'crossover' moving averages produced the best profit is shown next for the S&P 100 (OEX) and the Nasdaq 100 (NDX) Indexes. Note that ALL charts are as of the Tuesday (3/7) Close.

S&P 100 (OEX) DAILY CHART:
The simple optimization test I ran, at least for buys (hey, it's been an UP market!) indicated that using a 6-day and 21-day moving average crossover was the most profitable. This assumes a 'mechanical' use of the moving average crossovers by buying every time the 6-day moving average crossed above the 21-day average and exiting when that was no longer true.

And, like all use of moving average indicators such as in 'trend following' methods, when the market goes sideways, you have the delightful phenomena known as being 'whipsawed' as a result of the shorter average crossing back and forth multiple times BEFORE there is much of a point gain from getting in on the upside crossover.

NASDAQ 100 (NDX) INDEX; DAILY CHART:
Not surprisingly because they are related market indexes, the optimal two moving averages used for an optimal (two) moving average crossover indicator for the Nasdaq 100 (NDX) were not hugely different. But it was different, at 7 and 25 days.

Needless to say, moving averages FOLLOW emerging and ongoing trends, versus the use of some indicators like stochastics, RSI and MACD that I wrote about in my last 3 (Wednesday) columns, to ANTICIPATE trend reversals. More on moving averages after a brief update of my market outlook.

A MIDWEEK TECHNICAL UPDATE:

The S&P, both the 500 (SPX) and the 100 (OEX) broke below the low end of their two week old trading range and dipped to the are of the 21-day (simple) moving average, my key 'trading' average for the indexes. It has seemed likely that the S&P up trendlines would be reached and the indexes are getting near to them. Hard to predict whether prices will pierce them, since they so often act as strong support. The OEX rebounded to close back above its 21-day average today, so is hanging 'tough' so to speak.

The most bullish change in my indicators is in my call-put 'sentiment' model which continues to fall as shown above. This is a contrary indicator in that the more bearish that traders get collectively, the closer we tend to get to a bottom or eventual bottom.

The Nasdaq is another story and we've seen the two market diverge quite a bit during some periods of the past 12 months. The Nasdaq 100 (NDX) pierced ITS up trendline and fell under its pivotal 21-day average. Since the Nasdaq, like the S&P may just be retreating to the low end of its multi-month trading range, I wouldn't read too much into these technical tea leaves.

What is key is whether the Index can hold above the low end of its range at 1645-1640; a couple of closes below this area, especially back to back, suggests a next downside objective to as low as 1600.

There's a fair amount of talk about a possible big Head & Shoulder's top formation in NDX that shaped up with the highs of December (left 'shoulder'), the January top (the 'head') and the nearly equal to Dec top seen recently (possible right 'shoulder')

Again, I won't read much into this major top stuff unless the 1640-1645 area (the 'neckline') is pierced; if so, a pretty significant top would be suggested by such a break of the late-Dec/Feb lows.

BACK TO MY MOVING AVERAGE DISCUSSION:
The 'move' in moving average refers to the fact that the value of the average changes as you move forward in time and drop off old data. In the case of a simple 10-day moving average, based on the Close and applied to a daily chart, the most recent 10-day SMA is the sum of the closing prices of the last 10-days divided by 10. Once the trading day is over, the current or most recent Close will cause the close of 11 days ago to drop off as a new ten day calculation is made.

The Simple Moving Average (SMA) is the most common type of moving average and one that I use almost exclusively, as well as being the type that I would say is in most common use. Unless a chart with a moving average applied to it says otherwise assume the average is an SMA.

The SMA is sometimes the only 'type' (e.g., Simple, Weighted, Exponential) moving average choice for 'the' moving average indicator on charts on web sites that have technical indicators that can be applied to price charts. This is not the case of charting applications like Q-Charts, TradeStation, etc.

WEIGHTED MOVING AVERAGES
With the technical analysis software packages, there is usually an option to give more weight to the most recent price activity. A 'weighted' moving average assigns a greater percentage value to the closes for X number of recent bars, whether that bar represents an intraday period (e.g., hourly), a day, a week or a month, thereby giving a REDUCED weighting to older prices. (The practical effect is to make the weighted moving average line follow current prices more closely, with less of a lag than a regular simple moving average.)

Such 'front-loading' is the most popular method of calculating a weighted moving average but is not the only possibility. A variation called linear 'step-weighting' assigns a fixed increment weighting to each day that is dependent on the duration of the average. For example, in such a 5-day weighted average the most recent days close is 5 times the weight of the first day of the 5-day period; the prior day is 4 times the weight of the first day; the third day is 3 times the weight of the first day of the period and so on.

EXPONENTIAL MOVING AVERAGE
The 'exponentially smoothed' moving average is a type of weighted moving average that is a popular moving average variation and is probably best known through its use in the Moving Average Convergence Divergence (MACD) Indicator. This method allows recent price activity to generate a more rapid change in an average price. A type of 'smoothing' is applied; one that assigns a percent value (for example, .15), to the last bar and this value will be added to a percentage of the previous days close.

Because of this method of calculation, all daily moving average values are modified once the first exponential weighting occurs. The higher the percentage weighting given to the most recent close, the more sensitive will be the resulting moving average to the most recent price change. All data previously used is always part of the new result, although with diminished significance over time.

In the Microsoft daily chart below, a 50-day simple, weighted and exponentially smoothed average are all applied. For a 50-day average and this period of time, the distance between any moving average TYPE (Simple, Weighted, Exponential) relative to the latest Close, especially when there is a rapid price change, is least with the weighted moving average and greatest with the Simple Moving Average (SMA):

You'll note then in the chart above that we were alerted the quickest to price penetrations on the 50-day WEIGHTED moving average; it provided a faster 'trigger' on taking or shifting stock/options positions. Much of the time this faster trigger did not bring major time differences in when prices crossed above/below the different averages. However, there were and are periods when small differences in timing are significant in trading results over time.

When you DECREASE the 'length' (number of trading periods or 'bars' referenced) setting to smaller numbers, such as '21' in the Google (GOOG) chart below, you'll note that the differences between the SMA, Weighted and Exponential moving averages narrow in correspondingly.

To gain a more sensitive 'trigger' to changes AFTER a trend gets underway and while keeping the same length (21 in this case), traders will often increase the WEIGHTING for the last Close or last few closes, as is seen below with the Weighted moving average. Same chart, same 21-day average, but the stock now is quicker to cross above or below the new Weighted Moving Average.

The advantage of the quicker reacting weighting of a weighted moving average is getting out of a position quicker when the trend momentum, up or down, slows. A principle disadvantage, assuming you are mostly relying on the moving average to get you into or out of a position is being 'whipsawed' and having an increased number of losing trades.

In what can be a more effective use of giving STRONGER weight to the most recent close(s), making it a more 'sensitive' average, is as a tool to exit a trend AFTER a big/prolonged move already.

Get back in the stock or Index only when a quicker reacting indicator and trend analysis suggest getting back in the direction of the dominant trend; and possibly then only for SHORTER-term price objectives. OR, get back in when the intermediate chart pattern (e.g., a break of a major trendline) or OTHER intermediate indicators suggest (e.g., a Moving Average Crossover) suggest that the intermediate trend has reversed.

I'll have more to say on moving averages next week and will continue this thread and discuss my favorite type and setting for moving average as well as using moving averages to suggest support and resistance.

MY INDEX TRADER COLUMN:
This Wed. Trader's Corner article also serves as an adjunct to my weekend 'Index Trader' column. In the article you're reading here I can briefly update a technical picture of the market as of midweek, and then use recent chart/indicator patterns to more fully explain their relevance to trading decisions in general.

More on my specific predictions, support and resistance, etc. is found in my weekend Index Trader column, available on the Option Investor.com WEB site (not part of the e-mailed weekend OI Daily). You will see a web LINK to the Index Trader at the top of your weekend Option Investor Daily e-mail. My most recent (Sat, 3/4) Index Trader can also be viewed online by clicking here.

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **
 

Today's Newsletter Notes: Market Wrap by Linda Piazza, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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