I sell a lot of covered calls to bring in cash flow, but buying good stocks on the low side can sure improve the odds of making money. I use one indicator to help me buy low and another to help me see when it might be a good idea to sell shares.
Of course, to use these indicators you will need to learn a bit about setting up and reading a chart. Don’t let that scare you — if an old dog like me learned this stuff so can you.
Charts: step by step
Some investors have no use for charts. I would have a few hundred thousand dollars more in my stock accounts if I’d learned how to read charts earlier in life, and then learned how to believe them.
There are two parts to charts: learning how to set them up and read them, then believing them. I can teach you how to set up a chart but you’ll have to decide whether you’ll believe them or not.
I use one indicator to help me decide when to buy: the stock symbol compared to the S&P index.
For example, I’ll take you through a chart of Tourmaline (TOU), step by step.
First, go to www.stockcharts.com and click on “free charts.” There are lots of options on this page. Just type tou.ca in the box at the top and click “go!”
When the chart comes up on the screen, look for the word “indicators” near the bottom left side of the screen. You’ll see three horizontal boxes underneath “indicators”. One should read “RSI.” I would click on the box under “position”, and choose “below.”
Then, on the next box down, I would click on the menu area for “MACD,” and choose “full stochastics.” Then set the “position” for this at “below.”
Finally, I would go to the empty third box, and left click on the menu arrow to bring up a menu. Find “price performance” (near the top), and left it. The symbol $SPX should show up in the box next to “price performance.” Put your cursor in the box with $SPX and, with the left arrow, move your cursor to the left of $SPX (so the box reads: “tou.to:$SPX).
When you click “update” under all of these boxes, you’ll get the chart for TOU.TO: $SPX — a ratio of the stock symbol and the SPX index. When that ratio/chart is rising, the price of the stock is going up faster than the $SPX index. When the ratio is falling, the shares are falling faster (or rising slower) than the $SPX index.
The idea is quite simple. If a good stock has gone down a lot and turns up, its price will often rise faster than an index. That’s a good time to own the shares, although of course there’s no guarantee. When we see a rising chart, we might not want to sell calls on those shares just yet.
I have to thank Brooke Thackray and Don Vialoux for introducing me to this ratio at our Technical Analyst Society meetings.
There is another decision point: when to sell stocks. In this case, I use the same free chart and look at “overlays” (scroll down the page you were just on.) The default settings will usually show 50- and 200-day moving averages. Put your cursor in these boxes to change the settings to 10 and 30. Then click “update.”
Now, you should see a chart of TOU with the tou.to:$spx chart. On the body of the chart, you’ll see two lines. Usually the blue line is the 10-day moving average (10 dma).
Many times in the life of a stock when the stock price goes below the 10 dma, the price is headed down. Of course, the tough part is believing the chart.
Seasonality plays a big part in successful investing. The old saying “Sell in May and go away” doesn’t always work — stocks bottomed in March, 2009 at the end of the bear market.
However, most years some version of “sell in May and go away” does reduce risk. Don Vialoux put it this way at our meeting: from late October to early May, many predictable events happen. These include: weddings in India, farmers buy gold after harvest in India, Christmas, RRSP season, fiscal year ends, Chinese New Years in late January and annual meetings. All of these are predictable, happen annually and can raise the price of many shares.
After early May, there’s still Memorial Day and July 1, but most other significant market moving events happen at random. Markets don’t particularly like random, so many shares drop after April (although the exact timing varies by a month or so).
Add a big picture
One more indicator I’ve learned about is the symbol $spxa200r. If you type that indicator into the symbol box on Stockcharts.com (the box at the top that we used before), you’ll see a chart of how many shares are trading above their 200-day moving average. There is something almost mystical with the 200 dma.
If you set the indicator on a three-year chart, and look at how the black line crosses the blue 50-day moving average you will see almost to the day when stocks bottomed and topped.
To understand the market a bit better, look at charts in two steps. Step one: look at $spxa200r. If the 200 day chart is above the 500-day moving average, it’s a sign that, generally, the market is moving up.
Or, if you already have a list of favorite stocks, test each one by comparing it to the $spx. When you find a stock with a rising chart, the price of that stock is rising faster than the S&P index. It might be okay to use that indicator to decide whether or not to buy a stock. But if both charts are rising, it would likely be a lot safer.
With Silver Wheaton (SLW), one of my favorite silver stocks, a person could have used charts to profit from trading SLW over the past two years. The indicators have shown quite clearly when to buy and sell. The last sell signal was around the end of February, 2012, when the stock was around $39 per share. There were two sell signals. One was that the price crossed the 10-day moving average going down. The other was that the chart of slw.to:$spx peaked and started to move down. That chart has not turned up yet.
We sellers of covered calls would have been wise to sell a covered call on SLW at its support price of around $26 to $28 for June. June is often the low point for silver stocks, and July is often a good time to own precious metal stocks. Selling a call at the support price would have brought in $10.50 per share, which would have protected the portfolio as shares dropped from around $38 to under $28.
With generic drug maker Teva, I bought shares when the drug Lipitor came off patent. I paid $42.50 for the shares and have sold calls to pick up around $3 per share. That drops my per share cost to $39.50 so when the shares dropped the other day to under $42 I was not too concerned. I might buy a few more shares when the teva:$spx chart turns up.
Some say that timing the market is impossible. Well, maybe so for them. But there is a lot of free data available and computers that make charts for us. A half decent understanding of charts, such I have outlined here, can help us understand when to be in the market, when to buy good stocks at a good price and when to sell them. And if we buy and the price suddenly turns down, we have to be smart enough to cut losses short.
The old saying that a picture is worth a thousand words applies here. Charts give us a picture of what big money is doing with a stock. It’s not usually wise to argue with what big money is doing. †