Technical Analysis

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A useful tool for trading and investing

Technical Analysis (TA) is one of the methods that we use to make investment and trading decisions by analysing historical price movements. By looking at price charts we’re able to gauge the supply and demand for a security, allowing us to better forecast its future direction. Essentially, it allows us to gain an understanding of the market sentiment, where we can see if traders/investors are being greedy/acquisitive or fearful. In essence, it’s a tool which we can use to measure the mood of the market and potentially take advantage of the market’s behaviour.

TA assists us in choosing which trades/investments that could provide good opportunities to be involved in, the ones to avoid and others to keep an eye on as a future trade/investment.

We believe that it’s important to use TA in conjunction with fundamental analysis (FA). Fundamental analysis allows us to look at the economic and financial factors that affect the business, and TA is the timing tool that we use to assist with entries, exits and the managing of risk in our positions.

It’s important to understand a few key definitions when considering TA:

Support: A price level at which traders/investors have historically shown buying demand.

Why it’s important: If a security is falling, we can use this level to place a buy order as we expect the price to be supported by market demand. Conversely, if a support level fails, this can indicate that the supply is outweighing demand and that near-term falls may be likely. The support level can be a position where stop losses are placed to manage risk in new or existing positions.

Resistance: A price level at which traders/investors have historically shown a willingness to sell, providing the market with supply.

Why it’s important: We can use these levels to consider where to take profits, or if we’re looking at a new entry, we may decide to hold off and wait for a better opportunity on a pullback. Conversely, a break above a resistance level may indicate that supply for the security has run out and that appreciation in the near term may be likely. Placing a buy order above a resistance level can assist with entering a security which has a higher probability of appreciating, as demand is likely to outweigh supply.

Trend Line: A line which is drawn either below the price pivot lows to show price support, or above the pivot highs to indicate levels of resistance. The trend lines can assist with determining the speed and direction of the trend of a security, with a break potentially indicating a change in sentiment and direction.

Moving Averages (MA): A type of indicator which is used to smooth out the price movement of a security over a certain time frame. It can assist with predicting the overall direction of the trend. We use shorter or longer MA’s depending on the time horizon of our trade/investment in the security. The 50-day and 200-day MA’s are the most commonly used and discussed in the media. A break above/below the MA, may act as another tool to indicate a change in direction in the shorter or longer term.


Technical Analysis in Action – Telstra (TLS) – The trend is your friend

Prior to 2011, TLS shares were in a downtrend following a period of declining earnings coming out of the GFC and structural changes in the telecommunications industry. In 2011, TLS broke through the downtrend line, which could be considered the start of the new uptrend with the stock also above the 200-day moving average as the market started to assume a turnaround in earnings. While it wasn’t the lowest price achievable in TLS, rather than trying to catch a falling knife, buying on the upward price breakout provided a higher probability that buyers had come in to support the stock, and that further price appreciation was likely.

During 2014-2015, we saw a period of strong price acceleration (greed/acquisitive thinking) as the market chased the TLS price higher. The break down through the $6.00 price level was the first major warning sign that the uptrend was potentially about to come to an end. In 2015, we saw the combination of the price making lower highs and lower lows (the technical definition of a downtrend according to Dow Theory), the price break down through the 200-day moving average, and a break down through the long-term uptrend line. Some buying support was seen around the $5.00 mark through 2015-2016, but once the price broke down through this level, it was a strong indication that the demand from buyers had dried up with the supply of stock from sellers taking control of the price action.

Quite often, particularly in blue chips, when a security falls to multi-year lows it’s perceived as offering good value. As such, we tend to see value buying supporting the price and we see an initial bounce off these lows. More often than not, this just serves to provide another opportunity for sellers that weren’t able to exit earlier, to have another chance at exiting. Psychologically, these investors may have been reluctant to sell at the lower prices, but with the stock trading back to the higher levels once again, they place orders on to sell the stock which only serves to create further supply in the market, in turn creating a “resistance level”.

Following the second break of $5.00 in 2016, we saw the price almost immediately fall down to $4.00 as the market priced in a further deterioration in earnings and a cut in dividends. TLS bounced, but once again quickly resumed the downtrend as sellers continued to chase the price lower (fear). The stock hit the $3.50 level which provided a short-term level of buying support, but with the stock remaining in a long-term downtrend, and with ongoing expectations that earnings would fall, and dividends would be cut, TLS traded within 5c of its 10-year lows ($2.55).

The market is expecting that earnings will be substantially lower than last year (consensus forecasting FY19 EPS to fall by around 30% and dividends to fall to 17c from 27c). With buying support being seen around the all-time lows of $2.55, there’s a strong possibility that the bad news has been factored into the price and the worst could be over for TLS. In the short term, the $3.25 - $3.50 range is likely to act as a cap on the price (resistance). A break above this range would indicate that TLS is back in an uptrend. In all likelihood, we expect the stock to be range bound between $2.55 - $3.25 over the next year while the business looks to turn around its earnings.

With signs that TLS is stabilising, a pullback below $3.00 is likely to provide a reasonable entry area for clients looking buy the stock near historically low prices, with the $2.55 level likely to continue act as a strong support level.

Figure 1. Telstra (TLS) share price - 10 Year Weekly Chart (price as at close 18/2/19) (Source: S&P Capital IQ)

We can see that by using technical analysis, we are able to look for turning points to assist with providing higher probability entries and exits. TA also helps us to avoid securities which appear to have further potential downside, until we’ve seen signs of stabilisation.

Michael Ron
Research Analyst

T: +61 (0)8 9263 5264
E:
mron@djcarmichael.com.au


Disclosure Disclaimer

This Technical Trading Note is not a full research report. This document has been prepared in order to assist investors make decisions about their investments. It is based on technical analysis only. The views, price targets, support and resistance levels expressed in this document rely on the subjective interpretation of historical price charts and historical volumes. The outcome of any analysis is not certain and past performance is not a reliable indicator of future performance. The future performance of the company may be influenced by a range of company-specific and market factors.

For an explanation of technical analysis and charting terms, please refer to https://www.asx.com.au/prices/charting-library.htm.

This article expresses the personal view of the Author. DJ Carmichael Pty Limited, including authors of this report, its directors and employees advise that at the time of publication they hold or may become entitled to securities of the issued capital of the company and/or earn brokerage and other benefits or advantages, either directly or indirectly from client transactions in stocks mentioned in this report.

DJ Carmichael Pty Ltd is a wholly owned subsidiary of DJ Carmichael Group Pty Ltd ACN 114 921 247. In accordance with Section 949A of the Corporations Act 2001 DJ Carmichael Pty Limited advises this document contains general financial advice only. In preparing this document DJ Carmichael Pty Limited did not take into account the investment objectives, financial situation and particular needs (‘financial circumstances’) of any particular person. Accordingly, before acting on any advice contained in this document, you should assess whether the advice is appropriate in light of your own financial circumstances or contact your DJ Carmichael Pty Limited adviser. DJ Carmichael Pty Limited, its Directors employees and advisers may earn brokerage or commission from any transactions undertaken on your behalf as a result of acting upon this information. The information contained herein relies on information obtained from third parties. While DJ Carmichael Pty Limited believes that the information herein is accurate, no warranty of accuracy or reliability is given in relation to any advice or information contained in this publication and no responsibility for any loss or damage whatsoever arising in any way for any representation, act or omission, whether express or implied (including responsibility to any persons by reason of negligence), is accepted by DJ Carmichael Pty Limited or any officer, agent or employee of DJ Carmichael Pty Limited.