When looking for new trading opportunities, one should consider looking for stocks trapped in compression zones. These
are places on a chart where 3 or more of the major Moving Average (MA) lines come within
close proximity of each other…the price will often be close to the
intersection of the 3 major MA lines and the Bollinger Band (B.B.) outer walls will
contract into a tight space.
The major MA lines on my charts are
the 3, 13, 50, 100 and 200 (and sometimes the 400). Some people may
substitute the 20 or 21 ma line for the 13….others may substitute the
10 ma for the 13. I like the 13 because it is in-between all of these
and seems to work well. Some old-timers or those who follow indexes or large cap stocks prefer the 65 day MA over the 50 MA line.
Compression zones mark areas of
indecision….some bears are shorting to drive the price down while some
bulls are accumulating and trying to drive the price
higher….eventually, the zone resolves itself one direction or the
other. Big things often happen from these zones….compression zones are
a good place for options traders to set up bets in both directions and
wait for volatility to set in and they cash out big no matter which way
However, some compression zones can last for months. Generally, a trader should look for stocks that trade on good volume or that show a previous history of large moves (known as “alpha” to professional traders). After all, some stocks are mostly ignored or are otherwise boring to most traders, and so these stocks tend to spend most of their time in compression zones. So, let’s be sure to exclude the boring stocks and look for stocks that normally trade with greater volatility and higher volume, at least when they do begin to move (one way or the other).
The opposite of compression zones are what I call “widespread zones.” These zones arise after a stock or index has made a major trend move (higher or lower, it doesn’t matter) to the point that the price exceeds the direction of most of the major MA lines. Also, the MA lines will be spread far apart. When you find a stock price exceeding this zone, one should be wary that the trend and direction could be nearing an end soon. In many cases, bottoms can be spotted from a widespread zone. Or in the case of hot stock or index, tops can be spotted, or at least a period of consolidation may be setting up to allow the major MA lines to catch up to the price.
Also, for those novice traders who don’t understand how the
hedge funds and their machines control the markets, notice how each time
KORS gets down to the 200 day line, it finds support and
rebounds….this shows institutional support (often seen with the 50 day
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A trader on the Ace Talking Stocks Forum recently asked this question…
what we know is true, we could get a bounce a day after the 50/200
cross each other for a day or two and then the big decline would start.
Should that materialize, then it would be a perfect opportunity to
short it early next week again after a bounce of a day or two. What do
you think and how would you play it? In other words, what should one
look for in order not to be tricked by the bots and to jump in only if
the opportunity is offered on a golden platter.”
My response was:
assume you are referring to AAPL? Anyhow, the bots typically continue
to sell off UNTIL the major cross is reached….on your AAPL chart, the
50 and 200 have not yet crossed–but it is in this period as the two
lines draw closer together that the hardest selling often occurs….then
WHEN they DO CROSS, the bounce back will occur, and that could last
anywhere from about 2 to 7 days, before more selling comes in. Yes, the
Bots try to trip up the latecomers who are reacting to a major cross
such as the 50 and 200.
Why are the 50 and 200 day lines
considered so important? Ask a 100 traders this question, and perhaps
one or two know the answer!
But there is a rhyme and reason to
using the 50 and 200 day lines over, say a 35 day line and a 125 day
line….which to me are meaningless.
It’s because the base
premise of the existence of the 50 day is that it represents 10 weeks of
trading (5 days in an average trading week x 10 weeks=50 days)….10 is
the base number of the decimal number system and it is that base that
most modern math is based on (the other base system being the binary
system used by computers). Therefore, the 50 day is a good mid-term
The 50 day MA line works best with technology stocks or
other momentum plays (decimal system relates to tech stocks!)….for
what it’s worth, notice that the 50 day line is one of three key lines
in my Mo-celerator charts, which are designed to work with momentum
For slower moving large caps, such as Dow 30 stocks, the
favored mid-term measure is the 65-day MA line….something we rarely
talk about on this forum, but check out the Wall St Journal charts
which typically track S&P 100 or Dow 30, and you will see the
65-day line used instead of the 50. The 65-day is equal to 13
weeks….the 13 weeks is precisely equal to 1 quarter of the
year…..and how often do companies report their earnings? (Quarterly,
And the 200 day represents 40 weeks of trading (5
days x 40 weeks). The 40 weeks represents about 3/4 of the year in time,
and therefore, is a good long term measure. Therefore, the 200 day line
is roughly equal to a period of time that covers 3 quarterly earnings
reports….and the direction and movement of the 200 day gives us a
pretty good idea of the longer term trend of a stock since it covers 3
quarterly earnings periods.
(Originally posted on December 6th on Ace’s Talking Stocks Forum.)