Originally published by Guppytraders.com
The very best technical analysis helps us to put aside our hopes and dreams and our assumptions so we can get a more objective analysis of a stock. But even that is not enough because we have deep seated and hidden biases that predispose us to interpret events in particular ways. Some people are naturally suspicious, whilst others are more welcoming.
In the market it's these deep seated biases that stop us from seeing the obvious disaster hurtling towards us until after its gone and we have been injured. Fortunately in the market there is a simple technique that can overcome this critical bias.
Consider this anonymous chart. It’s a classic breakout environment. 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 recent support and resistance level has acted a support point for the rebound.
The Guppy Multiple Moving Average (GMMA) relationships support the trend break analysis. The long-term group has compressed and turned 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 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 with a move towards the previous resistance levels (not shown on this chart extract)
There is only one problem. This analysis is applied to an inverted chart of the Australian XJO index. Our conclusion is that the trend breakout will continue and in reality lead the XJO back to a retest of lows near 5800 and then the lower support level near 5730.
Yet the consistent commentary around the XJO index is that the market will continue to move higher towards 6150 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 leading international financial technical analysis expert and special consultant to Axicorp. Guppy appears regularly on CNBC Asia and is known as "The Chart Man". Disclaimer: Daryl Guppy is not a financial advisor. These notes are for educational purposes only and provide an example of applied technical analysis.