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What’s going on team? Today we are back with another Options Trading Strategy video where I document my thoughts and trades utilizing the wheel strategy. If you want to learn more about the wheel strategy I have made a series of tutorial videos where I dig deep into each part of the strategy. I will link them down below so you can check them out!
Today I want to talk about Technical Analysis and how I use it when I’m trading options using the Wheel Strategy. Then after I talk about the indicators I use, I will demonstrate them in action with an actual trade.
Also this is a good time to mention that if you enjoy these videos please consider subscribing to my channel! I really enjoy making these videos and it would mean alot to me. It also helps me out a ton to know that people are finding these videos helpful and enjoyable to watch.
Alright let’s get into the video!
Let’s start off with what technical analysis is. According to Investopedia, “technical analysis is a way to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume” https://www.investopedia.com/terms/t/technicalanalysis.asp
So what does this mean? Well in simple terms it means you take in what is happening right now… or what has happened in the past to make an educated guess at what will happen to the stock’s price next. This isn’t the same as fundamental analysis where we look at the company’s financial situation, business plan, its CEO, or
Let’s not confuse this with a cause and effect situation. Technical analysis does not tell you what WILL happen in the future. It’s true that history tends to repeat itself, that is why we use technical analysis, but that does not mean it has to repeat itself. You can not control the news of a company nor can you expect to predict the price action every time.
I just want to say this again. Just because history tends to repeat itself, that doesn’t mean it has to. Got it? Good!
Alright so now that we have a basic understanding of the idea behind technical analysis let’s dive into what technical indicators I use on a daily basis to help me determine my options trades.
With that being said… on to the indicators!
My top 4 indicators I use are:
- Support & Resistance Lines
- RSI
- MACD
- Moving Averages
Before I go in depth on any of these, I want you to remember that these technical indicators are all ways of describing past price action. Did you hear that? I’ll say it again for those in the back….these indicators are all ways of displaying past price action. This means that they don’t describe future price action. They are just different ways of looking at how the stocks price has moved in the past.
So now that we know that the indicators don’t tell the future, they only show us what has happened in the past…we can jump right into the first indicator: Support & Resistance Lines.
Support and Resistance lines are lines you draw on a stock’s chart on areas of price consolidation or in simpler words: the spots where the price tends to hangout for a while and or change direction. Let’s take a look at a chart of AMD. Over the last few weeks you can see that AMD likes to trade between $59 and $49 and we can clearly see that there is a support at $49 because in the past when the price has been near $49 this is where the buyers enter therefore it it called a support because the price tends to not go lower than $49. There is clearly a resistance at $59 because if we look at past price movement you can see the price runs up to $59 and it looks like this is where the sellers enter causing the price to stock moving up thus this is why it’s called a resistance.
So now how can I use support and resistance lines to trade options? Well if we are using the wheel strategy we can sell our put contracts at or below the support line because we know that in the past the price tends to not go lower than it. If we already own 100 shares of a stock we can sell our call at or above the resistance line because we know in the past the price tends to not go above the support.
When a stock price starts moving up from a support that is a short term BULLISH signal. When a stock price starts moving down from a resistance that is a short term BEARISH signal. These signals should not be used solely as investment decisions but they can certainly help you come to your decision of whether to enter into a trade now or when to hold off.
Now to the RSI aka Relative Strength Index.
I’m sure you’ve heard that either a specific company or the stock market overall is overbought or oversold. Well when they say overbought or oversold the indicator they are using to determine that is 9 times out of 10 the RSI indicator.
So what exactly is the Relative Strength Index? Well according to Investopedia the RSI is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset. Blah blah blah
https://www.investopedia.com/terms/r/rsi.asp
But what actually is it and how can we use it? Well let’s take a look at an old chart of Visa. This line chart at the bottom of the image is the RSI. You will notice that above 70 is considered overbought and below 30 is considered oversold. You can think of overbought the point where demand typically runs out and the sellers take control driving the price down with profit taking, and you can think of oversold as the point where supply is abundant and where the buyers typically come back and take control driving the price back up.
As you can see on the chart the direction of the RSI is very similar to the direction of the price. That is because the RSI is a representation of past price action. So it literally is a depiction of how the price is moving.
The RSI is Bullish when the slope of the line is pointing up. Which means the RSI is bearish when it is pointing down. The RSI turns from Bullish to Bearish typically when getting into Overbought territory. So something to think about when selling options is…..
if the price is currently Overbought then it is likely to have a small pull back. If you own 100 shares of a company that means you can sell your Covered Call closer to the money in anticipation of that pull back. If you are selling a cash covered put and the price is overbought you want to sell at a strike price slightly more out of the money (likely for less premium) in anticipation of the pull back.
If the price is currently oversold then it is likely to have a reversal and begin to recover. If you own 100 shares of a company that means you would want to sell your covered call slightly further out of the money for less premium to avoid assignment. If you are selling cash covered puts and the price is oversold, this is a good indicator that you can collect a little bit more premium by selling closer the at the money in anticipation of the reversal and recovery of the stock price.
This by all means is not a comprehensive mathematical explanation of the Relative Strength index but it is essentially how I use it to determine my entry and exit points when selling options or trading shares.
Now to the MACD aka Moving Average Convergence Divergence
https://www.investopedia.com/terms/m/macd.asp
The MACD is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26 Exponential Moving Average (EMA) from the 12 EMA. MACD is often displayed with a histogram (see the chart below) which graphs the distance between the MACD and its signal line. If the MACD is above the signal line, the histogram will be above the MACD’s baseline and GREEN in this case. If the MACD is below its signal line, the histogram will be below the MACD’s baseline. Traders use the MACD’s histogram to identify when bullish or bearish momentum is high.
How I like to use the MACD is very simple. If you take a look at the MACD chart you will notice there are 2 lines and in the background there is a green and red histogram. When the blue line (aka the signal line) crosses the yellow MACD line that is BULLISH. When the yellow MACD line crosses the blue signal line that is BEARISH. You will notice whenever the blue signal line crosses the yellow MACD line the histogram in the background is green and typically the price on the chart is moving up. When the Yellow MACD line crosses the blue signal the histogram turns red, and the price on the chart is moving down.
Now how do you use this when trading the wheel? Well if you are selling puts, depending on if the MACD is bullish or bearish should tell you how far away from current market price you should sell your contract. If you have a bullish crossover that should signal that it is ok to sell closer to at the money. If you have a bearish crossover that should signal that it is smarter to sell further out of the money since.
Same goes for selling covered calls. If there is a Bullish cross, sell calls further out of the money. If there is a bearish cross then sell closer to the money for higher premiums.
And the final indicator I use is perhaps the simplest…Moving Averages.
Personally I like 2 simple moving averages on my charts. I know many people like to use the exponential moving average but I find that you can see patterns better with the slower moving simple moving average and the exponential moving averages are a bit too jerky for me.
So what moving averages do I like? Well 1st I always have a green 180 day moving average on my chart. This helps me gage the general direction of the price. Is it trending up? Down? Horizontal? Then further away the price is from the 180 moving average the faster it is falling and due to the law of averages it will eventually move closer to the line.
If the price is above the 180 day SMA that is a bullish signal for me and that means for selling puts I should sell closer to the money for more premium. If the price is below the 180 day SMA that means the price is trending down and I should sell puts farther out of the money. If the price is at the 180 day SMA that doesn’t help us much and there may be some uncertainty in price direction. Which brings us to the other moving average I like on my charts…the blue 9 day SMA.
This line helps us determine short term price action and direction confirmation. If the price is above the 9 day SMA that means there is confirmation of upward price movement, while if the price is below the 9 day SMA that is validation that the price is about to move downward.
Now let’s put it into practice.
Take a look at this chart of AMD from July 20th 2020. AMD is trading at about $56.
Let’s start off with support and resistance lines. I see a resistance at right about $59 and a support at $49. Based solely on support and resistance I would say this is still a bullish price because it is still moving up and we aren’t quite at the $59 resistance yet.
Next let’s examine the RSI. The RSI is at 65 which is pretty high and getting into overbought territory. BUT it is still pointing up so I would still be bullish here even though it is almost overbought. If you look back of previous RSI trends you can see that AMD has a history of going from oversold to overbought consistently so I would expect it to continue the trend.
Now let’s look at the MACD. The MACD had a recent bullish cross of the signal line over the MACD line. This is third third Bullish sentiment in a row.
And finally lets look at moving averages. The price is both above the directional green 180 day SMA line and the blue confirmation 9 day SMA line. Which are both bullish signals.
So far we have bullish price action below the resistance line, bullish RSI, Bullish MACD crossover, and are above the two SMA lines we care about. So that means if the current price is $56 I would be happy selling a cash covered put at the money for a high premium with the anticipation the price continues to move higher. As for selling covered calls that is a different story. Since the overall sentiment is bullish we need to sell the call far out of the money to avoid an assignment. Ideally we would sell above our $59 resistance line and probably go with something like the $60 strike or the $61 strike. This gives you slightly less in premium but allows for upward price movement and more capital gains. Without taking the risk of assignment.
Well that’s it team. If you enjoyed the video smash the like button and subscribe to my channel for more. Make sure to check out my other options trading strategy videos and also my options trading series where I showcase actual trades I make. See you in the next one. Peace.
The Wheel: https://youtu.be/_uKo-bO35-Y
Covered Call: https://youtu.be/SrBTqAVtqjo
Cash Covered Put: https://youtu.be/yDpMKDZdJe4
Robinhood (Get 1 free stock): https://robinhood.samkling.com
Charts I use: https://charts.samkling.com
M1Finance: (get $10 free): https://m1finance.samkling.com
Webull: (get 2 free stocks): https://webull.samkling.com
