In the world of stock analysis, fundamental and technical analysis are on completely opposite sides of the spectrum.
Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a stock, which means the study of everything from the overall economy and industry conditions to the financial condition and management of companies.
Technical analysis, on the other hand, is the evaluation of securities by means of studying statistics generated by market activity, such as past prices and volume. Technical analysts, like myself, use stock charts to identify patterns and trends that may suggest what a stock will do in the future.
We read a stock chart in four different ways.
1) Price record of the stock: The graphic chart display makes it easy to compare today’s price with prices paid in the past. Once we see 260 days of price behaviour we also immediately observe certain patterns of price behaviour.
2) Emotional record of the crowd of buyers and sellers: Their emotions change over time as they grow to like, or dislike, the stock. This emotional record appears on the price chart as trends. Uptrends reveal when the market falls in love with a stock, while down trends tell us when the love affair has ended. These trends are easily seen.
3) Exact record of crowd behaviour: We look for repeated chart patterns, which point the way to high probability trading events such as a rally from a triangle pattern.
4) Translation of price activity: This is closer to literary criticism. We take the text, ie prices, and interpret the information. A moving average line is a simple indicator that provides technical analysis or interpretation of price data.
Price trends are exciting because we can see the opportunity to make money if we buy stock at the bottom of a downtrend and sell it at the top of an uptrend. It is easy to find these turning points on a chart of price history, but much more difficult to do in real time.
The objective in trend trading is to find a strong, established trend several weeks after it has started. Then we ride the trend until it has proved that it has ended. The trend may last weeks, months or sometimes, years.
To illustrate my points, Singapore-Listed Fraser Centerpoint, which is one of my personal trades, provided a 102% return over 11 months. The chart is a record of the emotions of the crowd and it charts their behaviour.
If we ride the trend we need to know when to get off. We use a chart-based signal to make this decision. One of the most effective is a straight edge trend line, as seen in Fraser's chart.
A correctly plotted line appears to have an uncanny ability to define the trend. Prices move away from the line, then fall back to the line, hit it, and bounce away again. Some people see this and believe that a good trend line is able to predict what will happen. Not true. The line predicts what we will do when particular events happen in the future but it does not predict how price will behave. The trend line is a trade management tool.
The trend line simply tells that prices are still moving in a rising trend and that the crowd emotion has not changed. When prices drop below this line they tell us there is a strong probability that the uptrend, as we defined it, has ended because there is a change in crowd behaviour. Stay with this stock and we could start losing money and profits. Trends are the clearest evidence that prices in the market are not random.
When the trend line flashes a signal we need to make a decision about our involvement with the stock. We may choose to act on the signal, to look for another signal to confirm it, or ignore the signal completely.
The Fraser Centerpoint trend uses a translation of price activity to understand the changes in crowd behaviour. The (GMMA) display defines the trend. The GMMA Trend Volatility Line is a critical analysis of the trend. When price closes below the TVL line then its time to exit and take a 102% profit.
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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