Moving Averages

We assign technical ratings to our stocks using a proprietary system. This system is based primarily on the 50-day and 200-day moving averages. The ratings range from -5 (worst) to +5 (best). From a trading perspective, we would like to buy securities that are moving from negative to positive and add to the position as it gets more positive. Conversely, we would like to sell securities that are moving from positive to negative.

To arrive at the rating we look at several factors:

1. Slope of the 50-day MA
2. Slope of the 200-day MA
3. Position of the 50-day MA relative to the 200-day MA (above or below)
4. Price of the security relative to each MA

The condition of these factors produces a value of +1, -1 or 0. The sum of the factors generates the rating. An example may be helpful:

The factors for Natural Gas:

• 50-day MA slope is negative and generates a value of -1
• 200-day MA slope is negative and generates a value of -1
• 50-day MA is below the 200-day MA and generates a value of -1
• The commodity is below the 50-day MA and generates a value of -1
• The commodity is below the 200-day MA and generates a value of -1
• The total is -5

Here’s another example:

The Utilities Sector ETF:

• 50-day MA has a positive slope and generates a value of +1
• 200-day MA has a negative slope and generates a value of -1
• 50-day MA is below the 200-day MA and generates a value of -1
• The shares are above the 50-day MA and generates a value of +1
• The shares are below the 200-day MA and generates a value of -1
• The total is -1

Our trend-following portfolios use this system. The idea of the system is to scale into securities after they’ve made a bottom and add to the position as the rating becomes more positive. An initial purchase is made when the rating is -1 (50-day MA rising and price above the 50-day MA). Subsequent purchases would be made when the stock rises above the 200-day MA and when the 50-day MA rises above the 200-day MA. A full position would be held as long as the stock is above both MAs and both MAs are rising. If the stock subsequently falls below the 50-day MA the position would be reduced. If the stock falls below the 200-day MA, no matter the condition of the other factors, all of the position would be liquidated.

We developed this system based on research done by a variety of individuals (here’s an article by Mark Hulbert that discusses some of the research). Most of the research concentrates on the use of the 200-day MA as a timing tool for the stock market, but we wanted a system that reacted to shorter-term signals. Waiting to buy until after crossing above the 200-day MA would mean missing too much of an initial rally out of a bear market and giving back too much of the gain after a peak. This system is more active and there are sometimes false starts, but that is why we scale in and out. We don’t want to make big bets in either direction. This system won’t get us all in at the bottom nor all out at the top, but is a more gradual system.

These ratings should not be used in isolation. It is necessary to know how the rating is changing. A stock rated +3 that is falling from +5 may not be as good a buy as a +3 that is rising from a -1. We also do not buy stocks based only on technical analysis. Thorough fundamental analysis is necessary in order to assess the risk of owning any security.

Point & Figure

We also assign technical ratings based on Point & Figure charting. Point & figure charting takes into account only the price movement of the underlying security. It does not take into account time or volume. We use weekly charts with a box size of 1 and buy-and-sell signals are generated using the standard three box reversal. The list of buy or sell ratings is based on the configuration of the chart when updated. It may have changed since the update so you should check other sources before trading. Also, point & figure buy or sell ratings are not the only criteria we use on point and figure charts. A stock that has formed a long tail down may be listed as a sell, but in reality may be due for a countertrend rally. A stock that has formed a tall column of Xs may be due for a countertrend correction. Point & figure charts are just another tool in deciding what to buy or sell and shouldn’t be used as the sole reason for buying or selling. For a very thorough explanation of point and figure charting, we suggest you read the explanation at Stockcharts.com

Disclaimer