The Moving Average Envelope indicator has proven useful as a 'signal' to buy calls on downside extremes, especially when RSI and Bullish Sentiment also reach key lows.


"Do you still want to buy the S&P even though below 1060 on this latest plunge?"


Yes, except today I was working with the idea to buy calls when SPX traded in the 1255 area. More on adjustments to my thinking shortly.

I had taken an educated guess this past weekend in my Index Wrap commentary that the S&P 500 (SPX) would offer good rebound potential if it got into the 1070-1060 range. Of course with the huge sell off yesterday (8/2) SPX closed at its intraday low UNDER 1060. Usually a Close at the Low such as seen with yesterdays Close (see below) suggests that there was unfulfilled selling, with a good possibility that prices would sink still lower. My daily SPX chart, reflecting the Close YESTERDAY (8/2) is below.

I had been using moving average envelopes that were set to show a value above my 21-day 'centered' moving average at 3 percent and an equal value below the average at 3%. I used simple moving average envelope lines relative to a 21-day moving average in an attempt to gauge upper and lower extremes; i.e., trying to judge where the lows and highs of our current SPX index price range would fall. Mostly, the S&P (both the 500 and 100) and the Dow tend to trade within 3 percent of the 21-day average in 'normal' market conditions.

One simple change I made yesterday on the fierce sell off was to make a change from 3% to 4% envelopes. My thinking was that because the most recent high was 4% ABOVE the 21-day average, the next low could be at or BELOW 4% as well. As above, so below; and vice-versa (as below, so above). My next chart after this following chart reflects this change and today's close.

As I noted already, the last intraday SPX high at 1356 reflected a value that was 4 percent above the centered moving average. Setting the lower moving average envelope ALSO to 4% gave a value of 1255 for the lower envelope line today. The area of this lower envelope became the zone where I had the most buying interest.

I always try to anticipate bottoms and tops when I can as I can get the best prices on calls when many traders and investors are caught up in panic and fear. This happens over and over and is the most 'consistent' thing about using market indexes to evaluate trading strategy.

Bottoms tend to be 'spike' lows and today's looks like at least an interim bottom. Anyone who is long calls around recent lows, yesterday and today especially, is advised to set an exiting 'stop' out point to this trade at just under today's (1234) low if on an intraday basis OR on if there is a Close below 1255.

Along with a PRICE level that might be attractive, I'm also looking for a 13-day Relative Strength Index (RSI) reading that's at or under 30 AND a call to put ratio (CPRATIO indicator above) that's into my 'oversold'/extreme bearishness zone. Both of these events occurred today.

The 13-day RSI at today's intraday low was registering a value of around 26. RSI is calculated at the close for a final daily value but during the day this indicator reflects the last price 'as if' it were the Close. At least this is the way technical indicators are usually set to update in real time.

With the greater volatility of the Nasdaq indices I use the same 21-day moving average but with the upper and lower envelope lines usually set to 4% above and 4% below the centered (21-day) moving average; sometimes its warranted to bump up these values to 5% above and below the centered average, especially with the Nasdaq Composite.

My next chart of the Nasdaq Composite (COMP) is in fact set to upper and lower values of 5%. The last intraday high (2879) was in the area of 5% above the 21-day average and it is often the case that 'extreme' follows extreme and the next low might well also reflect a value at 5% UNDER the centered moving average which was the case today. At today's 2621 low the RSI was registering a 30 value, which is a definite oversold extreme. It wasn't necessary to spend the day watching the market and these indicators; yesterday's closing RSI at 35 put this indicator within my oversold extreme zone.

A final note on the Nasdaq concerns the Nasdaq 100 (NDX). This index has held up the best on the last selling wave and I was less likely to think that I needed to EXPAND my simple moving average envelope lines from 4% (to 5%). In fact the chart shows my lower support highlight at 2265(at the green up arrow), unchanged from my Saturday (7/30/11) commentary. The 'support' I was anticipating was quite close to today's NDX intraday low at 2254.9

The simple moving average envelope lines are very useful in terms of not only suggesting that the index in question is at an 'oversold' or 'overbought' extreme, but at WHICH price levels where that would be the case.

A final question is whether the upper and lower envelopes lines reliably define 'support' and 'resistance'. They don't exactly, but at lower extremes especially, the lower envelope values often mark a tradable bottom.

As to how to determine WHICH percent values to use and WHEN to adjust those values, I leave to your reading my more comprehensive article on how to make effective use (in trading) of moving average envelopes in the major stock indexes, which can be viewed via this LINK to my Trader's Corner article (of 8/27/10).