Stock Price Cycles and Their Use in Covered Calls

Covered call investing techniques use stock price cycles, which are an inherent part of the stock market. Stocks never move straight up or straight down; they move in cycles. This article describes how Compound Stock Earnings views price cycles and is taken from the book Covered Calls and LEAPS: A Wealth Option, written by Compound Stock Earnings' founders Joseph Hooper and Aaron Zalewski.

Correct analysis of stock price cycles is important when establishing new covered call positions or when implementing one of the many techniques for covered calls developed by Compound Stock Earnings.

You must recognize that stocks move in distinct price cycles. Movements between parallel lines characterize these cycles. What you want to do is identify a price channel or a price cycle (these terms are used interchangeably). The way to identify a price channel is to draw two lines (preferably parallel) connecting the bottoms and the tops of a chart. A good source for free charts on the Internet is BigCharts. If you select "Java Chart" and then check "Draw Trendlines," you will be able to draw cycles on the chart. For covered calls, you should assess a stock using a 12-month chart.

Upward Price Cycles
In an upward cycle, the tops of the cycle are getting higher and the bottoms are also getting higher. An upward cycle has higher tops and higher bottoms. Start by drawing a line connecting the bottoms on the chart, because the buyers are in control of the market and driving prices higher. Then attempt to identify the top of the price cycle by drawing a line that is parallel to the bottoms. Note: Assessing cycles is not an exact science and absolute accuracy is not a contributing factor to the success of Compound Stock Earnings' techniques for covered calls.

Downward Price Cycles
In a downward cycle, the tops of the cycle are getting lower and the bottoms are also getting lower. Start by drawing a line connecting the tops on the chart, because the sellers are in control of the market and driving prices lower. Then attempt to identify the bottom of the cycle by drawing a line that is parallel to the tops. Again note that absolute accuracy is not needed to achieve excellent results with Compound Stock Earnings' covered call techniques.

Horizontal Price Cycles
In a horizontal cycle, the tops and bottoms are not getting substantially higher or lower. A horizontal cycle has relatively stable tops and bottoms. In a horizontal cycle, the market is in consolidation and it is not important which line is drawn first.

How to Use Price Cycles with Covered Calls
The concept is simple. When selling covered calls, you want to be confident the stock price is moving sideways or up. Remember, if the stock price moves sideways you can sell new covered calls each month and receive a steady 3 - 6% cash flow per month. If the stock moves up, your covered call is exercised and your stock is called out, meaning it is bought by the person to whom you sold the covered call. You then have the 3 - 6% cash return plus all your money back from the stock, and you can execute new covered calls.

In our next article, we will describe how Compound Stock Earnings uses stock price cycles to determine which covered calls to execute.

For more information, visit our website at www.compoundstockearnings.com.