The weekly chart of the Australian listing for Rio Tinto shows this has been a remarkably simple trend trade starting in December 2008 with the trend confirmed in March 2009.
There are times in the market when nothing more complicated than a twenty cent plastic ruler is required for making good money – or in more modern times, a simple charting software package and a straight edge trend line.
Rio's weekly chart shows a significant support and resistance level near $61. This was important many times in 2007 and 2008. It provided resistance again from June to September when Rio rose in 2009. The next support level is near $53. This creates the lower edge of a consolidation band. Rio was traded in this sideways consolation band for 15 months starting from January 2006.
Trend lines show a dynamic change in the support calculations. The horizontal line shows a consistent level where the market believes the stock is at good value. The resistance level develops when existing stockholders decide that this level represents the highest achievable price. They sell to lock in profits because they believe the price is less likely to move higher. This valuation is remarkably persistent and consistent over time. These horizontal lines develop reliable rebound and retreat levels in the market.
Once the price moves above these levels then the level is used as a support level. When price retreats to this level potential buyers come to the market because they see this level as good value in terms of price.
These deceptively simple lines develop an important story with Rio. The first instalment is the fall below the sloping up trend line. This is the first time this has happened since the trend commenced in late 2008. The trend line has been a very reliable indicator of support with price consistently bouncing away from the line. The more times the line has been successfully tested then the more significant it is when the trend line tests fails. This makes the price break below the Rio trend line significant. It suggests the long term uptrend has ended.
The second instalment is the location of the horizontal support line near $61. This suggests the trend breakout will find good support near $61 and potentially develop a rebound from the level. Aggressive traders will buy in anticipation of this rebound. Cautious traders will wait to see if the price falls into the historical consolidation area. They are prepared to buy near the lower edge of the consolidation band at $53.
The straight edge trend line suggests the uptrend has ended. This condition is unlikely to be altered by earnings announcements. The historical support levels provide downside support targets for the fall. The nature and character of any rebound from these support areas is unknown. The end-of-trend signal does not automatically provide any clues to the development of any subsequent rebound. Traders will be ready to join any new uptrend development from the support area.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –.. He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
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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