by Ray Frazier

The chart below of Ebay is an actual bullish trade that I made between August 13, and August 17, 1999.  There is a flat line between 90.74 and 100.98, which is the resistance line that the stock had to cross before I would consider it was making a bullish move up.  The lighter curving line is the 21-day exponential moving average and the darker curving line is the 50-day exponential moving average.  My buy point was as the stock crossed 98, the resistance line.  You can see that the 21-day exponential moving average at that time was right around 98 to 99.  Notice that the bottom section of the chart indicates that the volume picked up to the positive as investors created a bottom for the stock at the $70 to $75 level.  This was our indication that we would be watching the stock for entry.  The second section of the chart indicates that MACD had also made a short-term crossover, as the shorter moving average crossed a longer moving average to the upside just one day later.  This was our second indication, or confirmation, that the stock was going bullish and had established the bottom.

So now we have confirmation from two indicators, and the next step would be to get confirmation from the stock price by seeing if it could cross its most recent resistance.  Therefore, the buy point would be as the stock crosses its resistance line, which would be confirmation of the two indicators shown on the chart.  Furthermore, as the stock crosses its 21-day exponential moving average, we get further confirmation of the bullish sentiment from investors in the stock.

In preparation of the stock crossing its resistance line, I had to decide on the type of option I wished to use.  In this case, since the indicators are giving short-term bullish indications about the stock’s direction, I went with a call option.  The next decisions are the strike price and the expiration date.  In this particular case, the resistance point for the stock was 98, giving me two immediate choices.  The first choice being 95, and the second 100.  I chose 95, as it was reasonably priced and in-the-money.

The expiration date also had two choices, August and September.  I chose August, in which there are only six trade days left before August expiration.  Then, I was ready to put in my order with my broker to buy an August 95 call contract when the stock crossed its resistance at 98.  On August 13, 1999, the stock finally crossed its resistance line at 98.  I put in my order online to buy the August 95 call and paid $6 per option, or $600 per contract, plus commissions.

Now let’s discuss when you should exit a position and take your profits.  In the following chart you will see two new lines drawn on the bar chart.  The lines are called Bollinger Bands and consist of the top most curving line and the bottom most curving line.  The bottom most band moves in conjunction with the stock price when the stock is falling and often acts as the bottom most range of the stock price.  The top most band moves in conjunction with stock price when the stock is rising and often acts as the upper most range of the stock price.  Bollinger Bands expand and contract with the stock price based on the most recent price movements in the stock.

Often times when a stock breaks above its resistance line or out of a chart formation, the stock price will touch the upper trading band.  From that point the stock will more than likely trade above the upper trading band and then will fall back to take a small rest.  This “rest” will allow the stock price to trade away from the upper trading band and allow room for the stock to trade upward once more. Strong moves in a stock price can have the stock trading way above its upper trading band.  In this case, if you had gotten in as the stock crossed its resistance line, the stock more than likely would move anywhere from 8 to 20 points or more on the upside.  It would be time to take profits.  Usually when a stock makes a strong move to the upside, you will see sellers come in to take some profits off the table.  Instead of a small “rest”, often times the stock will see a bigger setback.