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Using Relative Strength Index and Ultimate Oscillator To Trade Stocks

Sep 18, 2012 | Clorox Stock (CLX), Latest

There are a lot of technical tools available to investors, but the problem that many investors have is knowing how to apply those technical indicators to a trade to profit. Two technical tools that are among my favorite are the Ultimate Oscillator and the Relative Strength Index tool or RSI as it is referred to.

I use both of these tools combined to follow my favorite stocks and look for moments when the stock is deeply oversold and about to bounce. I don’t use them alone, but by following the steps below you can see how I use these tools in order to profit from an oversold stock.

This strategy works well on large cap stocks. It can be used on all stocks but I would stay away from a lot of junior stocks, speculative stocks or penny stocks. It’s because the strategy requires an investor to have some idea as to where support may lie in a stock. With large cap stocks finding support is reasonably easy whereas with speculative and many junior stocks, support levels can be just “fleeting moments” when a stock suddenly decides to decline.

For some investors they use this strategy to buy call options and other investors sell put options and still other investors buy stock for a quick trade which is what I know use this strategy for.

For many years when my portfolio was a fraction of the size it is today I started this strategy with the Relative Strength Index and then in the mid 1980’s I added the Ultimate Oscillator which improved it dramatically. Over a period of about 10 years I used this strategy to compound my portfolio. With this strategy I timed the entry moment to buy call options on large cap stocks. With practice many investors can become adept at picking the moment of entry based on the strategy signals, for when to buy the call options.

I often had call options jump 17% to 50% in a matter of a day or two. I then would cash out my position and look for the next setup on another large cap stock. Over a period of 10 years I followed 25 large cap stocks, primarily DOW stocks and grew my portfolio quickly. It was tougher back then because there were no computers, all the work had to be done on paper and I had to put in my orders both to buy and sell before I went to work. Then I had to wait until I came home to see how the trades ended up and what to do for the next day. Commissions were also a constant argument with brokers as I felt I was heavily penalized for doing smaller call option lot sizes.

Today technology and discount brokers have changed everything for the better. I can follow my list of favorite stocks daily and today since my capital is so much larger I do not do call options very often. Instead I prefer using this strategy for buying and selling stock for quick trades which are often just a day or two.

One of the best parts of this strategy is that by using large cap stocks, almost always dividend paying stocks, the risk of capital loss is minimized since I have a number of rescue strategies to assist when the trade turns down. For example when I bought call options and the trade fell the wrong way I would quickly exercise my option to assign shares, then sell in the money covered calls to be exercised out. Not only was I earning more income, but I frequently picked up dividends as well. In other instances I would immediately turn my trade into a bull spread. For example if I had bought call options at the $25 strike on a stock and the stock suddenly turned around and plummeted I immediately would sell the $26 call turning my trade into a spread.

Another strategy I often employed was using this Ultimate Oscillator and RSI strategy to set up synthetic stock positions since my portfolio was smaller during the 1980’s when I was building my portfolio. Take for example a stock trading at $25 which my strategy signaled me was ready to bounce. I could buy 5000 shares at $25 but it would cost $125,000.00 of capital. However a 2 month out in the money call option at $20, cost $5.70 X 3000 (30 contracts) for just $17,100.00 of capital outlay.  Then when the stock bounced to $26.00, the call option often moved to $6.45 for a return of $0.75 X 30 contracts or $22500.00 on my investment of $17,1000. This is a return of 13.15% for a day or two of work. But it wasn’t the return I was seeking but the actual capital increase. Rather than only being able to do one or two stock trades because I did not have $250,000 to invest, by using synthetic stock positions, I was able to do 10 to 15 such trades and could grow my portfolio by about $20,000 to $25,000 in a month. That money was then used to do even more of these trades compounding my portfolio.

Now long since retired, I still love this strategy and continue to use it for a stock trade here and there. I felt this strategy was worth sharing with others particularly as it is a way to grow a smaller portfolio. I will be expanding this topic to show how to use it to buy and sell options, set up rescue strategies and for combining option strategies to earn as much income as possible from the trade.

This is the first installment of the article and covers using this strategy for the buying and selling of stock for day or swing trades. (short-term trades)

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