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Basic stock technical analysis and charting techniques

Many traders rely solely on Technical analysis to give them the indicators they need to press the BUY or SELL button. As I outline in my Investment Approach, I do not place a huge reliance on technical analysis signals when making an investment decision, the simple reason being, technical analysis works until it doesn’t. In the long term the stock price always reverts back to the risked discounted cashflow generated by the company. In my view to make money from the stock market consistently a deep appreciation of the fundamentals is therefore required.

That said the technical picture is the aggregate of the other market participants views so it shouldn’t be ignored either. Technical analysis can therefore be a useful complement to deep fundamental analysis and on that basis it can though help you to take better positions and therefore squeeze out additional margins on your investments. Moreover, used correctly the charts can also help you identify resistance points in stocks and momentum/trends in either direction which can provide a very useful sanity check on the logic behind the fundamental analysis that you (should) have already done and the resulting valuation you place on the stock.

I am not an expert in Technical Analysis, nor do I desire to be, but I will introduce you to the techniques I use:

First step, get access to charting tools.

You don’t need an expensive charting package, there are many descent free services available which cover UK stocks. The basic techniques (and some more advanced) are all available with IG Index Stock Broker Accounts. This service also allows you access to Level 2 data and Direct Market Access on a range of markets, including the UK. I will come to these two topics in a future blog post but there are lots of information available on both only a google away. If you are happy with your existing broker you can also grab a free account with Vox Markets which also has basic charting tools available amongst many other features, which I covered here.

So anyway by now you should be staring at a blank chart, so now on to some techniques you can apply…

THREE CORE CHARTING TECHNIQUES 

I will use British Land (BLND) as a company to work us through the following techniques. I chose this company as it has had some interesting moves, it is also a stock I don’t know well, so it should avoid any bias creeping into my analysis.

1. Plotting the General Trends

The trend is very important to establish and if you do just one piece of technical analysis then this is the one you should do before making your final investment decision. It is an uncomplicated approach and it involves simply plotting a line on the highest highs and the lowest lows in the period.

This analysis will reveal one of three outcomes. An uptrend, which is a series of higher highs and higher lows with a downtrend showing the opposite picture. A sideways movement will show no clear trend. The time period you perform this analysis is also important, with in technical analysis a long term trend is seen as one over 1 year and an intermediate trend over one – three months with short term trends being less than one month.

My suggestion is you plot the trend over at least 1 year, but also look back further. The results of the this analysis is important as it shows the general direction of travel. Once this is established then it is important to ask some questions. If you are considering buying against a long term downtrend, why? What do you know that is against the general trend of the market?

Taking our stock British Land (BLND) and looking back 14 months from today, i.e. to January 2016, I have plotted a long term trend line and intermediate trend line as follows:

BLND Trends.png

The results show a long term downtrend and an intermediate trend down. There is a short term trend up in April which we will come back to this when looking at Resistance and Support levels as this deserves attention albeit it is not an established change in trend at this stage.

It is pretty clear here that the long and medium term picture is a downtrend. The stock has been unpopular and clearly a BUY here would be contrarian. I won’t attempt to do any fundamental analysis, but it is worth noting that the company is a part of the ‘BREXIT Basket’. As British Land is an owner of commercial property its’ fate is seen linked to the strength of London’s business sector. On this note you will see I have not tracked the lowest lows that were achieved in the immediate aftermath of BREXIT, which would result in a much deeper trend downwards. Perhaps charting purists handle these events differently but given this was a short term movement triggered by a ‘black swan’ event it I feel it distorts the picture.

2. Resistance/Support levels

The resistance and support levels are areas where supply/demand kicks in and the share price struggles to get past a certain price, i.e. a restitance level or fails to fall below another price, i.e. a support level. This analysis can identify a trading range which can be profitable to trade within and it could also indicate that BUY orders should be parked when the price is approaching the resistance level. It also should prompt the question as to why the market buys and sells heavily at certain points and whether you concur with these BUY and SELL targets based on your fundamental research.

This method involves drawing horizontal lines on the chart where the same highs and lows have been achieved repeatedly and/or where a clear sideways pattern can be observed.

Below is the chart for British Land (BLND) from October 2016 to April 2017, which is a smaller snapshot of the longer term chart above.

BLND Resitance Support

The chart shows us that the share had been trading between October 2016 and Mid April 2017 between 575p and 640p, i.e. a 11% trading range. Interesting features from above are A, B and D when the price approaches the support and rebounds from this level. Point C shows the first attempt to breach the resistance in late December 2016 and point E shows this resistance level was finally breached in late April, 4 months later.

We are looking at a fairly short period of time, but it is important in the context of British Land as this period follows the period immedatedly after the BREXIT vote and thus can be seen as the ‘new normal’. Questions to ask yourself from this analysis are why does the market sell off in 640p region and buy in the 580p region? Where are your BUY and SELL Targets? The resistance has though just been broken and the stock is currently trading at 650p, why? What facts have changed? If momentum is established, the theory goes that the stock is more likely to continue in the same direction, particularly after breaching resistance, so should you SELL at this point?

3. Simple Moving Averages

A moving average is a trend line of sorts. The moving average is the sum of all closing prices over the period, divided by the number of days in the period. So the 20 day moving average on the 28th January would take the sum the closing prices over the last 20 trading days and divide by 20. For example, If we assume the price was 550p for the first 10 days and 600p for the next 10 days then the 20MA would be 575p on the 28th January.

Moving Averages can be used to identify the breakouts or reversals and two particular terms or features can be noted to assist here. A price crossover is where the current share price breaks out from the moving average. The longer the number of days in the moving average the larger the assessment is against the current share price. A Moving Average crossover is another signal, this is where one Moving Average crosses another, for example a 50 day moving average crossing over a 200 day moving average.

Let take a look at British Land again…

BLND Moving Averages

You will note some features from the discussion above, i.e. point B is a price crossover, i.e. the 200 day and 50 day Moving Average is crossed in Mid April 2017, which is also highlighted above in method 2, a break of resistance. There is also a Moving Average Crossover in late April 2017. This analysis very much supports the short term bullish move as highlighted above and the same questions should be pondered, i.e. is the long term trend about to turn? What facts have changed to support this move?

It is also worth noting point A, the BREXIT vote. The stock drops upto 30% below the 200 day MA. On the face of it this could look like a BUY opportunity but clearly this was as a result of the BREXIT vote so it is very important to assess the facts that have changed before diving in.

SUMMARY – What can we conclude on British Land from the Charts?

The long term picture is a down trend, the short term picture is a period of momentum. As mentioned above, the important part of technical analysis is to look for fundamental rational for the technical picture moving. This is why the technical picture should never be dismissed though, the aggregate of the other market participants have formed a view and it should be understood why. So in the case of British Land, If I were looking to take a position then the questions I would be seeking an answer to are:

  1. There is a long term down trend. Why? Is this suitable as a long term investment?
  2. There has been recent resistance and support levels established, what do these levels imply for the valuation?
  3. There is a short term period of momentum with key technical bullish signs, including break of resistance, price crossover and moving average crossover. What has prompted this increase in sentiment? Is there any potential to reverse the long term downtrend? If I am an existing holder should I ride the momentum to squeeze out some further gains or consider selling at this level?

I hope this is a useful overview of the merits of combining technical and fundamental analysis. I will do a fundamental analysis of British land in the coming weeks where I will incorporate the technical analysis and attempt to answer the questions it raises.

Happy Charting!

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