The very best technical analysis helps us to put aside our hopes, dreams and assumptions, so that we can get a more objective view.
But even that is not enough because we have hidden biases that predispose us to interpret events in particular ways. Some people are naturally suspicious, and others are more welcoming.
In the market it is these deep-seated biases that stop us from seeing the obvious disaster hurtling towards us until after we have been injured. Fortunately, there is a simple technique that can overcome this critical bias.
Consider this anonymous chart. It is a classic breakout environment, to which we apply basic chart analysis.
Price has moved above the downtrend line in a sharp rally. This has been followed by an equally sharp retreat and a rebound from near the value of the downtrend line. The downtrend line has acted as a support level.
The Guppy Multiple Moving Average relationships support the trend break analysis. The long-term group is compressing and is turning up. This is usually associated with a trend change. The short-term group has also compressed and moved above the long-term group. This is another confirming indicator of a trend change.
The pullback has been more severe than expected with the short-term GMMA dropping briefly below the long-term GMMA, but the rebound is rapidly reversing that situation.
This is a clear combination of bullish factors and suggests there is a high probability that this rally and retreat is part of a longer-term uptrend. The immediate target is near the peaks of the previous rally which paused near the trading band.
There is only one problem.
This analysis is applied to an inverted chart of the Dow Jones Industrial Average. Our conclusion is that the trend breakout will continue and in reality lead the Dow back to a retest of lows near 23,400 and potentially to the downtrend line near 22,500.
Yet the consistent commentary around the Dow is that the market will continue to move higher towards 26,600 after a temporary retreat. This bullish outlook is wishful thinking because it requires a reversal of the current trend and this reversal is a low probability.
When we look at price charts our bias tends to be bullish. We can overcome this bias by inverting the chart. This is a type of blind analysis and it helps to give a more objective view about trend direction and strength.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders, which can be found at www.guppytraders.com. He is a regular guest on CNBC Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe. He is a special consultant to AxiCorp.
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