Identifying Trends

DoctorT

Hi!

I am a newbie planning to buy naked calls of large-cap and middle cap, common stocks traded in the NYSE and the NASDAQ.

Philip Thygesen of Stock Market Strategy (https://www.stock-market-strategy.com) suggests to first identify the trend. One way, I opine, would be to compare the current SMA (or EMA) versus a prior SMA (or EMA). For example, the current 200-day SMA (or EMA) is greater than 200-day SMA (or EMA) for a year ago. Does it make sense? If so, would use use a SMA or an EMA? What timeframes would you use?

Thank you!

Doctor T

markd

If you want a very bullish trend, then you would test for price above the 50 and the 50 above the 200, and both MAs rising.

You can test for a rising MA as you suggest, by comparing its current value to a previous value. But you can use a much shorter look back period - maybe a month (21 bars on the daily) to three months on the 200 and maybe 10 to 21 bars on the 50.

If you use a very long look back period, it's more likely that the trend did not exist for the entire time. It may have dipped and recovered instead. If you want a very long term trend, you could test it several times - e.g. current > 3 mos ago, 3 mos ago > 6 mos ago, etc.

In general, EMAs respond more quickly to price behavior than SMAs. That matters if you are using the MA as a SIGNAL - that is, price crossing above or below the MA tells you to enter or exit, or the short MA crossing the long MA. EMAs will track price more closely, so if price is behaving normally (not spiking in range), you will get a signal sooner with EMAs. That may or may not be a good thing. EMAs are popular, so professionals like to run the stops when the public gets in all at once. Of course, if you think that will happen, you can plan your entry where others enter their stops.

The choice of MA type is less important to determining trend. Trends last a while so both will give you valid information through most of the trend. EMAs will turn first, in either direction, but trends often have false starts and false endings, so you can be a little early.

You might also be interested in Wilder's Average Directional Index for identifying trends:

https://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:average_directional_index_adx

Also Chande Trend Meter:

https://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:chande_trend_meter

Finally, maybe you have read something I haven't, but I'm pretty sure a naked call is something you sell, not buy. It's naked if you don't own the underlying stock to cover your obligation to supply the stock to the call buyer when the stock price rises to the strike price. If you do own the stock, and are willing to give it up if it rises to the strike price, then you are selling a covered call. Normally you would do that in a flat or falling market for extra income. If you want to profit from the price change in the call when the stock rises, without owning the stock, that's just buying a call.

DoctorT

Dear Mark D,

Thank you for your reply.

I was speaking of buying calls without owning the stock. Thus, I was speaking of buying calls.

At first, I would just be looking for trends, not signals. Thus, I will follow your suggestion to use SMAs, not EMAs. Later, I'll look at Wilder's Average Directional Index and at Chande Trend Meter.

I also like your suggestions of (1) comparing several periods and (2) using shorter periods.

For example, I tested whether the closing price is higher than the 20-day SMA for today and for 5 days ago. Later, I'll add more periods.

Scan:[type = stock]
AND
[group is not ETF]
AND
[country is US]
AND
[[exchange is NYSE] OR [exchange is NASDAQ]]
AND
[optionable is true]
AND
[daily SMA(20,daily volume) > 500000]
AND
[daily volume > 500000]
AND
[daily close > [SMA(20, daily close) * 1.05]]
AND
[5 days ago daily close > [5 days ago SMA(20, daily close) * 1.05]]

Am I on the right track?

Doctor TR

markd

If you haven't already, you should back test it to see if it gets the results you expect.

To me it seems a little late - that is, the up leg has already made some progress if its above the rising 20 MA and sometimes might not have much left. But that's not always the case and if you are more comfortable with that set up, stay with it if your research tells you so. Also, considering the time premium and how long it might take for a trade to develop if you get in earlier, your approach might work better.

If you do want to consider an earlier entry, then in a longer term up trend (50 above rising 200) you might look at buying below the SMA 20. Call premiums could be lower, usually, when the stock has experienced a down leg. For a trigger you might research something like MA 3 x MA 5 or MA 3 x MA 10 (ema or sma, try both). However, getting off the bottom sometimes takes time, so you would probably buy in the money calls for one of the next expirations, not the current expiration, to lower your risk. Those will be more expensive than the current expiration, so your return could be lower. Just ideas - believe your own eyes and your own experience ahead of what anybody else says.