Stock Diamond - Technical Analysis Education

Overview:

In this newsletter, we will be building a screen based on price and volume growth. Combining these attributes in your screens just might add that little edge you have been looking for.

The 5, 20 and 50 day SMA and the 5, 20 and 50 day price ratio

The 5, 20 and 50 day ratio is the percentage difference from last close compared to the 5-day price average (sum of last 5, 20 and 50 closes divided by 5, 20 and 50 respectively). The simple moving average is the sum of the last 5, 20 and 50 closes and divided by 5, 20 and 50. Repeat for every day to create a line. The major difference, is that as a larger number of days is applied, the less sensitive the average becomes to the price movement.

Since moving averages are trend following systems, using a combination of numbers is ideal. The smallest value gives the warning and the largest value confirms the trend. In any breakout, the 5-day SMA will cross the price first, then the 20-day SMA; the 5 and 20-day cross; and, nearby/soon, the 50 day SMA crosses the price. Acting on the 5-day SMA is typically considered far too risky, while waiting for the 50-day SMA might put you in at the halfway mark. So in this case, we will be looking for the 5 and 20 cross -- and if the chart looks fine, then it's time for some grunt company analysis. But for now, we will only be looking at the screening stage.

In general, the following concepts apply when using moving averages and ratios:

1. Bearish: The 5-day SMA is above or has crossed to be above the price line. This results in a price ratio below 1 (5 day price ratio = close / 5-day average price).
2. Bullish: The 5-day SMA has crossed the price line (the last close is above the 5 day price average). A positive percentage tells us that the 5-day SMA is below the price line and that the short term price trend is up.

   The lower or higher the percentage is, the better our indication of the strength of the move.

Screening for your stocks

We will create a screen for the chart characteristics that are highlighted in the yellow box below.

This screen should be modified to suit your strategy. Here, it is mostly intended to describe the use of moving averages and ratios to screen for stocks. As in all cases, after you find a particular chart you are interested in, based on your trading system, further company analysis is highly advised to confirm the chart pattern/breakout. Companies that can meet both technical and fundamental scrutiny have higher success rates.

In the case of INTC, we will focus on several key chart characteristics. The technical portion for our screen will include a 5 and 20-day MA cross, and a price ratio that is above the 5 and 20-day MA yet below the 50 day MA. The problem with the signal in this chart, is that within the yellow box there was not any noticeable volume spike. The volume spike is a strong indicator of a trend change rather than just a correction. In this screen, we will also ensure that volume is increasing rather than declining by including a volume ratio (you can always run the inverse screen and look for shorts by changing the technicals from buy to sells, and using the less-than operator for the ratios).

Bullish Screen:

Technicals

Technical 1: 5-20 MA cross within the last 30 days

Technical 2: 50 MA cross within the last 5 days

Fundamentals

Fundamental 1: Price ratio 5 day - greater than or equal to - 1.01 (the price is trending up (on average) for the last 5 days and closed 1% over the 5 day average)
Fundamental 2: Price ratio 20 day - greater than or equal to - 1.02 (the price is trending up (on average) for the last 20 days and closed 2% over the 20 day average)
Fundamental 3: Volume ratio 20 day - greater than or equal to - 1.05 (the volume is trending up (on average) for the last 20 days and last daily volume was 5% over the 20 day average)
Fundamental 4: Close greater than 10 (last close over $10)
Fundamental 5: Close less than 80 (last close under $80)
Fundamental 6: Average 30 day volume greater than 1 million (minimum average 30 day volume should be at least 1 million shares per day, this ensures only liquid issues are returned by the screener)

StockScreener sample:

Results:

A total of 46 matches resulted in the above screen. Sorting the list by price growth, or by adding/replacing technicals to the screen, will greatly affect your Top 10. In this case I have not sorted the list to any particular order. When charting the results, you will find that while the moving averages and ratios match the search, some of the results tend to be too far up the trend or not acceptable for another particular reason. This screen should be modified with additional technical or fundamental criteria that match your trading style/system.

To build screens that match your trading style, start with a chart similar to the Intel chart above. This can be done for any trading style or system in 4 quick steps:

1. Find the company and chart pattern you would like to have traded.
2. Apply your indicators and identify the pattern of events that precede the move, for example: the 5-day moving average first crossed the price, then the 20-day moving average followed by the 50-day moving average. In each case, include a time frame. For example: a 5-day moving average cross within the last 20 days, a 20-day moving average cross within the last 10 days and finally, a 50-day moving average cross within the last 5 days. You do not have to use moving averages. Technicals will vary for every trader, so use the indicators that fit your system
3. Include any company fundamentals, in the case of the StockScreener this is where you will also find the ratios. Click here for other ratios.
4. Run screen and modify as necessary. Remember that no screen is perfect and there will always be some unwanted results. By following up good charts with company research you can reduce the risk of error.