Using the Dow Jones to Forecast OEX Index Options Market Movement

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For many years educated top traders and economists have discounted the value of the Dow. Many technical traders believe the averaging of only 30 companies does not represent the market well - as it doesn't appropriately include the NASDAQ or small caps - and that the Dow is irrelevant.

The Dow Jones Industrial Average (DJIA) is the most widely used indicator of the overall condition of the stock market. This is a price-weighted average of 30 actively traded blue chip index stocks and the primarily industrials. The 30 index stocks are chosen by the editors of the Wall Street Journal (published by Dow Jones & Company), which is a practice that dates back to the beginning of the century. The Dow was officially started by Charles Dow in 1896, at which time it consisted of only 11 stocks. The Dow is now computed using a price-weighted indexing system, rather than the more common market cap-weighted indexing system. Simply put, the editors at WSJ add up the prices of all the stocks and then divide by the number of stocks in the index. (In actuality, the divisor is much higher today in order to account for stock splits that have occurred in the past.)

At OEX Options, Floyd Epstein, President, thinks exactly the opposite! He says, "The theoretical Dow (a method of calculating a Dow Jones index) assumes all index components hit their high or low at the same time during the day.”

"Each day OEX Options provides the Dow projections in our pre-market alert. Traders follow the Dow projections to understand and "read" the short term steps to the market, and then trade OEX index options around the tops and bottoms of the Dow," says Epstein. "It's a way to day trade the stock market around "whipsaw." Most day traders think a whipsaw is a condition where an investor's security transaction is quickly followed by an opposite reaction. Sometimes referred to as "being whipped," Epstein says, "There is a familiar pattern to Dow movement...up 350 points, and down 350 points, over a period of time. When the market is very uncertain, and "fear and greed" are more prevalent, whipsaw (movement back and forth around a 100 point range, according to Epstein) is a great way to make money on short-term trends."

In other words, the "theoretical Dow" uses the daily highs for all 30 Dow components to calculate the index high; and the lows to calculate the index low. In January of 1992, Dow Jones started using the "actual" method, which calculates the index at 10-second intervals throughout the day. Before this point, the theoretical calculation was the only way to compute the high and low of the index." - Quote from Investopedia.com.

At OEX we use three methods of study to analyze the Dow.

1. Support and resistance longer range lines utilizing Point and Figure Charting. Point and Figure is a mainstay of how Floyd identifies bias, trend, and movement.

2. We see the market typically move in 'ranges' of 150 to 350 points, depending upon market conditions, and we utilize our own proprietary 'counting' method as to when these shifts occur. Ranges may be less, during whipsaw, but we watch patterns in short term Dow projections.

3. The Dow best translates to the OEX, and we watch and read the stocks leading the Dow and create an equal weighted index that we chart with Point and Figure. We believe knowing the projections and following them can be a key part of a traders success.

Epstein uses the theoretical Dow to project Dow movement over a 21 day period, utilizing point and figure charting, Bollinger Bands and support and resistance lines. (Bollinger Bands is a technical analysis technique in which lines are plotted two standard deviations above and below a moving average, and at the moving average itself. Because standard deviation measures volatility, these bands will be wider during increased volatility and narrower during decreased volatility. Some technical analysts consider a market which approaches the upper band to be overbought, and a market which approaches the lower band to be oversold).

Epstein says, "We trade only the S and P 100 stocks in the OEX, as simple put and call options which we hold a day to three days, and knowing that the Dow projections are a very simple way to "read the future" of the market."

About OEX Options:

OEX Options is an online stock options trading company that specializes in mentoring its clients to learn how to trade stock options on the stock market. The partners at OEXOptions.com have been trading for over 25 years. Established on the premise to make S and P 100 Blue Chip stocks a simple stock option trading system, OEX Options provides the average stock investor the tools and information to be successful. OEX Options is an online trading resource with daily “signals” and a complete method and approach taught to subscribers and is one of the top index fund option services in the U.S.

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