MAILBAG QUESTION:

"... and pleas explain how you use moving average bands in showing support and resistance?"

MY RESPONSE:

It can be useful to look at the major stock index price swings above and below a 21-day moving average in determining price levels where an Index is overbought or oversold. Use of the 'moving average envelope' indicator allows use of any moving average length (e.g., 5, 8, 13, 21, etc.) as a 'centered' moving average.

The upper and lower so-called envelope lines reflect values that are X percent above and below the 'centered' moving average that is a user-set input for the moving average envelope indicator. In the stock INDICES, use of the 21-day moving average has been an effective value to use as will be seen in my chart examples.

ENVELOPE VALUES IN THE INDICES:

The S&P and DOW:

Relative to the average of the Close of the past 21-days, the S&P and the Dow 'normally' will see price swings that are not greater than 2-3 percent above or below their 21-day Averages. In periods where price volatility becomes more extreme, the envelope lines CONTAINING most S&P and Dow (up and down) price swings can expand to over 3 percent such as to 3.5 to 4-5 percent. Examples in the S&P 500 (SPX) will be seen in low to normal, versus HIGH volatility periods, in my charts shown further on.

Declines down to the relevant LOWER envelope line often mark the lows of that move. Rallies to the relevant UPPER envelope line often marks a high, an interim peak OR brackets an area where upside momentum SLOWS and/or there are minor pullbacks and a sideways trend.

The Nasdaq:

Relative to the average of the Close of the past 21-days, the Nasdaq Composite (COMP) and big cap Nas 100 (NDX), in 'normal' or 'average' volatility periods, will see price swings that are not greater than 3-4 percent above or below their 21-day Averages. In periods where price volatility becomes more extreme, the envelope lines CONTAINING most COMP and NDX price swings can expand to over 4 percent such as to 5-6 percent, or a bit more at times. Examples in the Composite seen in low to normal, versus HIGH volatility periods, will be seen in my charts below.

The Relative Strength Index (RSI), stochastics, and MACD indicators will normally provide a reasonably good indication of WHEN an Index is either 'overbought' or 'oversold'. However, these type (overbought/oversold) indicators will not necessarily suggest the PRICE LEVEL where an Index is truly at an 'overbought' or 'oversold' extreme.

A high reading (above 70) in the 13-day Relative Strength Index (RSI) indicator in my last chart below, of the Nasdaq Composite, suggested that COMP was OVERBOUGHT initially at 4300, then again at 4500, and AGAIN at 4600. So, was COMP really at an 'overbought' EXTREME at 4300, or at 4600? Quite a range in prices!

Use of 21-day moving average envelopes for the major stock indices can suggest PRICE areas that are at upper or lower envelope EXTREMES. These trading bands become a yardstick for measuring upside or downside potential before prices move back toward a mean like a moving average.

The 'mean', in my examples the 21-day moving average, is the dividing line so to speak between indexes in accelerating (upside) momentum versus declining price momentum in a downswing. A major stock Index trading ABOVE its 21-day moving average suggests upside momentum with the moving average tending to 'act as' technical support. Trading BELOW the Average, suggests downside Index momentum and the moving average tends to 'act as' resistance.

INDU, which only represents 30 stocks, is somewhat more likely to see price swings that are contained within envelope values of 3 to 3.5 to 4 percent above/below its 21-day moving average in 'normal' (i.e., lower) volatility periods.

NASDAQ COMPOSITE (COMP):

COMP and the big cap Nasdaq 100 (NDX) will tend to see price swings CONTAINED within upper and lower envelope values of 3-4 percent above/below their 21-day Averages. Most up and down price swings in COMP and NDX are CONTAINED within such trading 'bands' or envelope lines.

Declines down to the 'typical' LOWER envelope line often marks the lows of that decline. Rallies to the UPPER envelope line often mark a key top, an interim high or an area where upside momentum SLOWS, and/or minor pullbacks and a sideways trend is seen as seen in my next chart.

The above examples of 'normal' price swings relative to a 'centered' 21-day moving average in the S&P indices and INDU, as well as the two key Nasdaq indices STOP being the norm in periods of high volatility that come along occasionally such as when an overall bull Market experiences a period, temporary or prolonged, where bearish fear and panic dominate as was the case in October (2014). Volatility spiked higher as highlighted below.

Along with the spike in Volatility as represented above in the S&P 500 Volatility Index (VIX), especially on the sharp sell off coming after what had been a prolonged up trend, a next bottom came at the EXPANDED 21-day moving average envelope value seen below.

In a volatile period the S&P's LOWER envelope value can reach -5 percent (more rarely, at -6%) under the 21-day average. Such a move will often mark a bottom and represent an area where the Index is NOT ONLY oversold but suggests the PRICE area where that is the case. The SPX decline to -5 percent UNDER its 21-day moving average seen below, as it turned out, offered a low-risk opportunity in calls or in other bullish strategies.

SPX's rebound back from the -5% envelope line (mid-Oct, 2014) and continuing in the move to above its 21-day average, rallied initially to an upper envelope value of +3.5 percent over the center Average. Setting an upper envelope value at +3.5 percent above the 21-day moving average suggests a 'rising line of potential technical resistance' going forward as highlighted on the SPX daily chart below:

In the Nasdaq Composite chart seen below, a lower envelope value of -6 percent under the Average, marked a bottom with bullish 'confirmation' by the oversold RSI and represented an area where COMP was NOT ONLY 'oversold' but suggested the price area where that was the case. The COMP decline to -6 percent UNDER its 21-day moving average represented, as it turned out, an ideal area for covering puts and a low-risk entry in Nasdaq related calls (e.g., in NDX options) or in other bullish strategies.

COMP's rebound from its -6% envelope line and continuing in the move back above its 21-day average, stopped initially at an upper envelope value of +4.5 percent. Setting an upper envelope value at +4.5 percent ABOVE the centered (21-day) moving average suggests a 'rising line of potential technical resistance' going forward, as highlighted on the COMP daily chart below:


GOOD TRADING SUCCESS!