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Friday, June 4, 2010

Explanation of TEMA Charts

This is a chart of CLF. The top indicator is Linear Regression which shows the short-term trend in stock prices. I use 12-day LR with a 12-day Moving Average. Why 12 & 12? Front month options (the most liquid) expire each and every month, and gamma scalping and position hedging by options traders dominate the marginal liquidity of each stock that has options.

The Point & Figure Trend also reflects the short term trend, although this indicator seems more reliable not to pointing out the future direction of prices, but rather to indicate that prices are likely to move away from the current price. Buying at-the-money straddle in options, whenever this indicator changes could be a good strategy.

The second and third indicators are volatility indicators that I use to determine whether a stock is moving or not moving (whether prices are trending or range bound). These indicators have a leading component in that often a jump in volatility from low levels forecasts a change in the established trend. They can also be used to forecast short-term future volatility in stocks, thus helpful in estimating whether implied volatility in options are overvalued/undervalued. Finally, I use trend lines to show the short-term trend or range and where the support and resistance levels are.

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