From a charting perspective the Australia-listed BHP Billiton has a messy chart.
We commonly use charts for analysis to help determine upside and downside targets. Our preference is to use charts to identify and manage trading opportunities. The chart analysis targets are just a framework for more exacting management of the trade.
BHP has been moving in a broad up sloping trading channel. Trading channels are similar to a trading band. A trading band is defined by historical support and resistance lines. A trading channel is defined by sloping parallel support and resistance lines.
The trading tactics for channels and bands are simple and profitable. The method buys when price rebounds from the support line and sells when price hits the resistance line. These levels are horizontal, so the exit price remains the same after every rebound from support.
With the trading channel there is extra incentive to hold onto the trade because the rebound after the next dip and rebound from support will give a higher exit point. The weekly chart for BHP shows how this strategy is applied, but with some important exceptions.
The dips below the lower trend line are exit signals. They challenge the integrity of this trend line placement. The strength of these challenges is more clearly seen on the daily chart with 3- and 4-day dips below trend line A.
How we place the trend line depends on how we want to use it. Our preference is to use the trend line as a trade management trigger. A close below the trend line A shows there is a high probability the trend will change direction. The trend line should capture all of the significant dips in the trend. It defines how far the price can fall and still remain consistent with the rising trend.
BHP has developed two false dips. They are false because although the deliver a trade exit signal, the market rebounds and the higher trend continues. A line plotted using these lows is trend line C.
So what’s the problem?
The problem in a volatile market is the confusion of valid exit signals between trend line A and trend line C. The current downside market volatility increases the probability the price will test trend line A. A rebound from this level is expected and traders may use this as an entry point believing it to be temporary price weakness in a well-established uptrend.
But a move below trend line A is not an automatic exit signal because trend line C has defined the support rebound points for false dips below trend line A. In a strong bullish market this is not a problem. In a market with emerging downside pressure there is a lower level of probability that trend line C will act as a reliable support level. A fall below this line has downside targets near $30.00 and ultimately near $23.50.
There are two clearly defined support and resistance levels on the weekly chart. The first is support near $23.50. Price did stage a heart-wrenching dip below this level in November 2008, but in broad terms this was a support rebound level. Remember, this is a messy chart and finding reliable levels is difficult.
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The second strong support and resistance level is near $30.50. This defined peak highs in 2006 and pile-driver pattern lows in 2007 and 2008. And it exerted very little influence as a resistance level in 2009 as the uptrend developed. That’s very bad news, because it suggests this level will also offer very little support in the price moves below trend line C.
Upside targets are also not well defined. We show resistance near $40.50 but this is not a well-defined historical area. The more recent resistance near $38.00 has a stronger influence.
Despite its size the conclusion from a charting perspective is to treat this trend with caution. There is a low degree of compression in the long term Guppy Multiple Moving Averages (GMMA) and this reveals underlying trend weakness.
When a sell-off develops there is a surprising lack of support from investors. The chart suggests this is a good stock for trading because of the rally-and-retreat behavior within the trading channel. But trade management is difficult from a charting perspective.
If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.
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