This is the third of a four-part series of articles describing an options trading system that accomplishes better than averages outcomes.

This first installment (Part 1) explained methods for selecting companies and quantifying technical attributes. The second installment (Part 2) explained the theory and its assumptions, and the selection of strong reversal or continuation signals

This installment (Part 3) provides examples of application for the quantifying tests, with strong and weak outcomes

The final installment to follow (Part 4) summarizes the methodology and outcome of a two-year test.

 This theory was first documented in a paper written for and published by the Journal of Technical analysis (JOTA), which subjected the concept to a rigorous serious of peer reviews. The paper was published in the 2016 edition of JOTA, issue 69: JOTA issue 69 The theory was expanded and explained in greater detail in “Profiting from Technical Analysis and Candlestick Indicators” (FT Press)

 

Recalling the assumptions listed in the first article in this series, this installment compares fundamental and technical confidence for two companies in the retail sector, Macy’s (M) and Target (TGT).

Macy’s was quantified first on a fundamental basis, where it scored 41% or 11 points of a possible 27 (fundamental results based on S&P Stock Reports):

 

Fundamental criteria, Macy’s (M)

Description points
Dividend yield 2
Dividends per share 3
Dividends raised, last 10 years 2
Dividend payout ratio per year 2
P/E, highest last 10 years 2
P/E, lowest last 10 years 3
Revenue per year -1
Earnings per year -1
Debt capitalization ratio -1

Target (T) was also tested against the fundamental rankings, and scored 74%, or 20 points out of a possible 27 (fundamental results based on S&P Stock Reports):
Fundamental criteria, Target (TGT)

Description points
Dividend yield 1
Dividends per share 3
Dividends raised, last 10 years 3
Dividend payout ratio per year 3
P/E, highest last 10 years 1
P/E, lowest last 10 years 3
Revenue per year 3
Earnings per year 2
Debt capitalization ratio 1

The next level of testing was based on the charts for each company, and identification of reversal signals and confirmation:

On the chart of Macy’s, the two days preceding the big upward jump after earnings formed a bullish harami cross. This was strongly confirmed by a volume spike and move of Relative Strength Index (RSI) close to overbought. As a result, the following technical rankings were estimated for Macy’s:

Technical criteria Macy’s

Description
proximity:

at or through resistance or support

close to resistance or support

signal at mid-range

 

 

2

Signal strength:

weak

average

strong

 

1

Confirmation strength:

weak

average

strong

 

2

Multiple confirmation:

weak

strong

 

2

Preceding trend:

weak

average

strong

 

0

This outcome was 7 out of possible 9, or 78%.

The same technical test was applied to Target based on its chart:

Target experienced a bearish doji star right at the point of resistance. This is a strong reversal signal; however, there was no confirmation, making it difficult to enter a trade at this point. The technical ranking reflects this:

Technical criteria for Target

Description  
proximity:

at or through resistance or support

close to resistance or support

signal at mid-range

 

 

2

Signal strength:

weak

average

strong

 

1

Confirmation strength:

weak

average

strong

 

2

Multiple confirmation:

weak

strong

 

0

Preceding trend:

weak

average

strong

 

0

The score was 5 out of possible 9, or a confidence level of only 56% — close to a 50/50 level, thus inadequate for generating a trade.

Even though both examples resulted in price movement as expected at the point of an earnings surprise, the Macy’s outcome created 78% confidence, whereas Target’s technical confidence level was much lower at 56%.

This two-part ranking (fundamental and technical) was used during the two-year test period resulting in better than average profitable outcomes. Although Target’s technical score was higher than Macy’s (74% versus 41%), the timing of options trades was the opposite, favoring Macy’s on a technical basis by 78%, over Target at only 56%.

These outcomes were easily correlated to one another. For the timing of an options trade based on signals and confirmation, Macy’s was a clear stronger candidate. However, neither example led to a failed signal. A large part of success in swing trading relies on skilled timing for both entry and exit. Thus, a chart with an exceptionally low technical score (33% or lower) would be a poor candidate for entering a trade. Success should be measured not only by successes, but also by potential failures that were avoided.