A simple-moving-average, also known as an s.m.a., can be among the most useful technical tools a trader will ever encounter. S.m.a.’s are often helpful in revealing the type of trading environment – for example, a price that consistently bounces higher from a 50-period simple-moving-average is generally a healthy, bullish sign. On the other hand, a price that falls below a 200sma can be a sign that it is a good time to consider closing longs and start thinking about shorting.
Not only are sma’s helpful and easy to use, they are popular too. This is especially true of sma’s on a daily chart, in which the periods of the moving averages are measured in days, such as:
- 10-day sma
- 50-day sma
- 100-day sma
- 200-day sma
While the above examples are only a few of many in use, the popularity of the above moving averages tends to increase their usefulness. That’s not to say that something like a 26-day sma is not useful. But, popularity does have some advantages. In some ways similar to a self-fulfilling prophesy, the sheer number of traders using the listed sma’s tends to cause an expected reaction when a price touches a particular moving average.
As an example: If a lot of traders set a stop-loss order just below a 200sma, each believing that a price falling below the 200sma is an indication of a loss of an important level of support, a price that does indeed fall below that level may result in a sell-off due to triggering of those stop-loss orders.
Click on Chart to enlarge
*All strategies involve at-the-money options opened 4 months (112 days) prior to this week’s expiration using an ETF that closely tracks the performance of the S&P 500, such as the SPDR S&P 500 ETF Trust (NYSEARCA:SPY)
Finding a moving-average that doesn’t move.
Despite the popularity and the usefulness of sma’s, they all have one thing in common that can cause headaches for traders– as their name implies, they all do one thing; they move. So, it is not possible to predict exactly where a moving average will be tomorrow, or next week, or anytime in the future. Thus, it is difficult to predict what reaction the market will have if the price reaches a particular level, because it can be difficult to predict how that price will compare to an as-yet unknown sma.
How can one predict if the S&P will break through the 10-day sma next Friday without knowing what the 10-day sma will actually be on that day?
The following analysis attempts to help traders identify levels of the S&P 500 which tend to coincide with particular trading environments. Exposing the current trading environment is the intended goal of analyzing some of the more popular simple moving averages, and also the goal of the following analysis, but the following analysis exhibits a distinct difference – the levels obtained in the following analysis do not change. Since the following levels remain constant, a trader may find them useful for such tasks as setting a stop on a stock, or choosing a strike price for an option, without the movement associated with a moving average.
You are here – Bull Market Stage 2.
On the chart above there are 3 categories of option trades: A, B and C. For this past week, ending April 5, 2014, this is how the trades performed:
- Covered Call trading is currently profitable (A+). This week’s profit was 3.5%.
- Long Call trading is currently profitable (B+). This week’s profit was 1.6%.
- Long Straddle trading is not currently profitable (C-). This week’s loss was -1.9%.
Using the chart above, we can see that the combination, A+ B+ C-, occurs whenever the stock market environment is currently at Bull Market Stage 2. For a description of Stage 2, as well as a comparison to all of the other stages, the following chart is provided:
