Technical analysis represents one third of the stock screening process in the BCI methodology. The other two are common sense principles (referred to as “descriptive terms for long-term investing) and fundamental analysis. Reading price charts is as much an art as it is a science and there is no one right way to technically analyze a stock- there are many. When I share the parameters that I use, they may not coincide with your favorites but as long as our rationale and goals are similar, the information should be useful to most of our readers.
This article will highlight the BCI parameters for long and short term technical analysis and the reasoning behind these selections. In the former, we are analyzing long-term buy-and-hold portfolios while in the latter we are analyzing for one-month option positions. Let’ start with our one-month option trade analysis:
Short-term technical analysis
The chart below represents a charting process geared to one-month positions:
1: 20-day and 100-day exponential moving averages identify trend and change rapidly as recent prices whipsaw. We look for uptrending moving averages with price bars (or candlesticks) at or above the shorter-term moving average. We have a bullish moving average indicator in this image.
2: The MACD histogram (blue bars)also identifies trend but is also a momentum indicator predictive of future price movement. In this screenshot, the MACD histogram is above zero and ascending, also a bullish signal.
3: The stochastic oscillator (black line) is also a momentum indicator, giving us a window into future price movement. A bullish signal is when it pushes above the 20% and is ascending as it has been recently.
4: Strong volume, as shown by number 4, confirms the signals from the other three indicators and also represents continuing fuel for the price acceleration. So we are four for four in the bullish signal department.
When signals are all bullish, we take a more aggressive stance in our option-selling positions (deeper out-of-the-money calls and puts closer to at-the-money rather than deep out-of-the-money puts. Mixed technicals will lead us to more conservative positions and all bearish signals will turn us away from considering that underlying security. We also use changing technicals to determine exit strategy decisions.
Long-term technical analysis
For a long-term buy-and-hold portfolio, our holdings do not turn over as frequently as they do when selling short-term options. Therefore, our time frame differs and so must our parameters for technical analysis. We are interested in a broader picture of the price action for the security so trend becomes of utmost importance. Reasonable time frames to evaluate trend are 50-day and 200-day simple moving averages.
With these indicators, each day is given equal weight whereas with option-selling exponential moving averages, more recent prices are more heavily weighted into the graph. While momentum indicators are not as critical for sell points and other position management maneuvers, setting a trailing stop loss order is an outstanding management approach. This technique allows share value to rise unimpeded while setting a maximize price decline from highest price point. Here is a price chart showing 50-day and 200-day moving averages:
Note that the shorter-term 50-day simple moving average (blue line) is above the longer-term 200-day simple moving average (red line) and both are uptrending, all bullish signals. Also significant is the bullish moving average crossover in late May when the short-term average moved above the long-term average (red arrow).
Discussion
Technical analysis is an art as much as it is a science. It should be crafted to reflect the particular trading style implemented and the risk tolerance of the investor. When executed properly, the analysis will assist in all aspects of our investment decisions.
Market tone
Global stocks were little changed on the week as markets awaited clearer policy signals from the incoming US administration. West Texas Intermediate crude oil fell slightly from a week ago, to $52.60 per barrel from $53. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), tweaked a bit higher to 11.54 from 11.20 last week. This week’s reports and international news of importance:
- In his inaugural address, President Trump pledged to transfer power from Washington, D.C., back to the American people. He called for defending the US’s borders while rebuilding its infrastructure. Every decision, whether on trade, taxes or immigration, will be made to benefit American workers and families, he said. While he expects other nations to put their interests first as well, he said the United States will reinforce old alliances and build new ones
- In the first appearance by a Chinese leader at the World Economic Forum in Davos, Switzerland, President Xi Jinping defended globalization. He cautioned other countries against pursuing protectionist policies, adding that no one will emerge as a winner in a trade war
- On the domestic front, Xi said that the economy has entered a new normal, driven by household consumption. He affirmed a 6.7% 2016 economic growth target, in the middle of the government’s 6.5%–7% range, but the slowest since 1990
- Interest rates will stay low or head even lower for an extended period, European Central Bank president Mario Draghi said on Thursday, after the Governing Council left its monetary policy unchanged
- US Federal Reserve chair Janet Yellen said Thursday that the Fed is close to its goals and that she expects to hike rates “a few times” in 2017. Futures markets have just over two 25-basis-point hikes priced in at present
- The US economy will grow 2.3% this year and 2.5% in 2018, according to freshly revised International Monetary Fund forecasts. The IMF raised its forecast by 0.1% for 2017 and 0.4% for 2018
- The global growth outlook remained steady from October estimates of 3.4% this year and 3.6% in 2018. The fund estimates that the global economy expanded 3.1% in 2016
- This week, several banks announced plans to move staff out of London in the wake of Brexit, including HSBC (NYSE:HSBC) and UBS. Meanwhile, Germany’s Handelsblatt reported that Goldman Sachs (NYSE:GS) may relocate half of its London staff of 6,500. Some jobs will move to New York, while approximately 1,000 could move to Frankfurt
THE WEEK AHEAD
MONDAY, JAN. 23rd
None scheduled
TUESDAY, JAN. 24th
9:45 am Market manufacturing PMI
10 am Existing home sales Dec
WEDNESDAY, JAN. 25th
None scheduled
THURSDAY, JAN. 26th
8:30 am Weekly jobless claims
8:30 am Advance trade in goods Dec.
8:30 am Chicago Fed national activity index Dec.
9:45 am Markit services PMI
10 am New home sales Dec.
10 am Leading economic indicators Dec
FRIDAY, JAN. 27th
8:30 am Gross domestic product 4Q
8:30 am Durable goods orders Dec.
8:30 am Core capital equipment orders Dec.
10 am Consumer sentiment Jan.
For the first week in 2017, the S&P 500 dipped by 0.15% for a year-to-date return of 1.45%.
Summary
IBD: Market in confirmed uptrend
GMI: 5/6- Buy signal since market close of November 10, 2016
BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes. I remain cautious as we enter another earnings season and the new administration clarifies its economic and political plans.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a neutral to slightly bullish outlook. In the past six months, the S&P 500 was up 5% while the VIX (11.54) declined by 1%.