When it comes to technical analysis, or ‘charting’, many investors are quick to write it off. But there are big advantages of being able to properly analyse charts. Today I’ll show you some of the benefits.
The ability to read stock price charts can give you a serious advantage over the rest of the market.
Personally I use charts as a backup tool — on top of other methods — to analyse a company as a potential investment. My first layer of analysis involves a list of eight criteria that are detailed for members of the Australian Investors Club. Then I take a look at the share price charts to confirm whether it’s a good time to be buying.
Last week I discussed the power of using charts to support your investment decisions and promised some simple tools to help get you started.
The following is a five year chart of property developer Stockland Group [ASX:SGP]. I asked you last week to consider whether you’d rather have bought at point A or at point B…or whether it even matters.
At both point A, in mid-2011, and again at point B, in late 2012, you would have paid $3.50 per share for a gain of around 28% today.
Since both A and B give you the same return, you might believe that it doesn’t matter at which point you bought the stock.
However, if in mid-2011, you were able to predict that the price was likely to fall, you could have had your money invested in something else and avoided holding Stockland to its bottom.
That’s important because waiting for a share price to hit its bottom then rise back up is idle time. Your money could be working better in a rising investment elsewhere.
Looking back I’d prefer to have bought Stockland in late 2012, when its share price was rising.
There are two simple tools you could have used in mid-2011 and again in late-2012 that would help you decide whether it was a good time to buy. They indicate that buying at point B was a better decision than at point A.
The first tool is support and resistance levels and the second is identifying when the stock is in an uptrend, rather than a downtrend. Of course, there are thousands of other tools you could use, but for today we’ll get started with just these two.
Support and resistance levels
Support levels are levels that a stock falls to, then bounces off. However when these levels are breached it can indicate a change in the market’s sentiment towards the stock.
Resistance levels are like a ceiling, or a price that a stock has trouble rising above. But once it does, it can indicate that the stock will continue to move higher.
Back to the Stockland five year chart. The green lines are support levels. When the share price fell to these levels it had trouble falling any further. But then, when it did fall below those levels at point A – in this case at around $3.50 – the stock fell sharply.
Then as the share price was rising it had encountered resistance on its way up at around the $3.40 level. Once it was able to move above this level at point B it continued to rise.
Another example of how you can use support and resistance levels can be seen when looking at a chart of the ASX 200 last week. The market suffered, fell sharply and it might have been tempting to sell. However, the chart shows that it remains within the range of prices it’s been trading at this year.
A sharp fall below the 5800 level — the green line — would suggest the market is no longer supported at that level and is heading lower. While a rise above the purple line, or around the 6000 level would suggest the market has overcome that resistance level and will head higher.
Buy the uptrend, avoid the downtrend
When a share price is rising it’s more likely to keep rising than to reverse its course. That’s equally as true for a share price that’s falling. It’s more likely to continue its course than to reverse.
So it’s important that you can recognise whether a stock is in an uptrend or downtrend.
An uptrend is defined as a price making ‘higher highs’ and ‘higher lows’. Higher highs mean consecutive peaks higher than the previous peaks. Higher lows are bottoms that are higher than the previous bottom.
A downtrend is defined as a price making ‘lower lows’ and ‘lower-highs’. Lower lows mean the current bottom is lower than the previous bottom. Lower highs mean the stock’s previous peak is higher than the current peak.
Looking back to the Stockland chart, you can see that from April 2012 the stock made a series of higher highs and higher lows. If you waited to buy stock at point B it’s true that you would have missed some of the returns when it bounced off its lows, buy you also avoided the fall. And you would have confidence that the share price was then trending higher.
As you can see, the tools you use don’t have to be overly complicated. You don’t need to filter through the hundreds of technical indicators and signals available for every stock.
But it is important that you decide on which tools you are going to use and then stick to them. Be consistent in the tools that you use and keep your emotions out of your decisions.
Analysing support and resistance levels and determining if a stock is in an uptrend or a downtrend are just the tip of the iceberg of technical analysis. There are thousands of different ways to analyse price charts.
Investment Analyst, Australian Investors Club