How can you determine which direction it is going to head, and will it have strength behind the move?
Stocks often move up and down or back and forth without any real strength, so is there a way to zero in not only on the direction but that there will be strength in the move? Because this discussion relates to options trading, it is important to focus on both upward moves for Call options and downward moves for Put options.
https://youtu.be/Y8nYVJK4BTk
An important indicator to use for options trading is called the Average Direction Index or ADX. It is created by 3 different colored lines: Green, Red and Black. If the green line (+DI) is on top, it is telling you the bulls (buy) is happening. If the red line (-DI) is on top, it is saying the bears (selling) is in charge.
The black line is sharing different information. It is a strength line. If it is flat, it means the price of the equity is flat and has no energy. If it is heading down, it means strength is weakening and if it is rising, it is showing strength in moving in and there is energy supporting the direction line that is on top.
For this example, there are some rough pink lines under the areas where the ADX line rose. Look to see what color line was on top. Red or green? If the red one was on top, price is dropping. If the green is on top, price is going to rise. The indictor is telling you a story. You can also look and know that when the black line starts to head down there has been a change and its strength energy is now going to slow down and price is going to lose strength from its previous direction.
Look across the indicator and determine when the red line was on top and the ADX was rising, you know price is dropping. Then notice when the green line was one top and the ADX was rising, price rose during those periods. Now look at the chart below to confirm what you saw by way of the indicator.
by Stockcharts.com
You will notice that directions begin to flatten out and begin to change as the lines head toward each other. One weakens and the other is getting stronger. The “real” strength happens when the black ADX line heads up and the brakes are applied when the black line flattens and heads down. The lines are sharing information or telling their story.
Last month, we discussed Call options and it was mentioned that this month we would discuss Put option opportunities. Now you have a way to determine when to consider buying Put options. Puts could be considered when the red line moves up to be on top and the ADX (black) line heads up.
Wendy’s goal is to teach everyday people how to trade options, to learn to read charts, and while they are learning, they can participate in a program like ALPHA that trades the daily charts of equities like General Motors (GM). I think of this as an earn-while-you-learn program that is perfectly suited for people who are interested in learning to trade options as well as have the opportunity to earn a profit as part of the learning process. Please contact FFR Trading today to discuss this further with Wendy Kirkland!