Technical Analysis or TA as it is often shortened to, is more of an art than a science. Even though there are plenty of mathematical elements to it.
The reason I say that, is because to use TA successfully in trading, often relies on interpretation and experience.
Traders and analysts that use TA, look at charts and decipher what they are saying, and what the message means for the price action ahead.
A group of people can all look at the same chart, notice different things, and come up with different conclusions and still not be wrong.
Like a lot of things in the markets, the successful use of charts is about probabilities.
In this case, working out what's most likely, or most probably going to happen next.
In simple terms there are only really three outcomes: the price will move higher, the price will move lower or the price will move sideways (remain largely unchanged).
Traders tend to be most interested in the first two outcomes, though options traders are likely to be interested in the third.
I like to use TA to build up a picture of what might be possible, in the price action going forward.
Like a detective, I look for clues to form a picture
Individually these clues might not seem significant but when combined, they can tell a different story.
The sort of clues or signals I look to look for, include patterns on candlestick charts, such as the one below.
Which is of UK engineer Weir Group, WEIR LN, over a 6 month time frame.
You may notice that I have highlighted the last candle in the chart, with a red box I have done that to bring it to your attention.
Why?
Well because its an important signal as far as I am concerned - known as a Bullish Engulfing pattern,
the candle envelopes the previous days range, making both a new low and new high in the process.
Source: Barchart.com
Why is that important you may ask?
It tells us that the bulls or buyers, have taken control of the price action, and in the case of Weir Group they have done so, after several days of indecision. As indicated by the previous three candles in the close up below.
Weir Group chart close up
Source: Barchart.com
The bullish engulfing pattern should put us on alert
However, it's important to remember that if you are looking at candle patterns on a daily timeframe they are not confirmed until the daily close.
This is where judgement and the balance of probabilities will play a part if you decide to act on the signal, before confirmation or /close of the period under observation.
The bullish engulfing pattern itself needs confirmation in the subsequent trading period too
So in the case of Weir Group, we needed to see the bulls/buyers in charge from the open the following day.
And, you can see just that, in the table below.
With the stock gapping up by +26p from the off.
That’s the difference between Wednesday’s close (last) and Thursday’s opening price.
Weir LN HLOC data
Source: Barchart.com
It's also notable that Thursday's high price in Weir Group of £26.66, was also a new 1-day, 5-day, 1-month, 6-month, year-to-date, and 52-week high.
Weir LN price performance
Source: Barchart.com
None of the above is a guarantee that Weir Group or the price of any other security will move higher but it does hint at the fact that they could.
Another example
To show how powerful a pointer the bullish engulfing candle can be, I have drawn a chart of Ocado OCDO LN, which gapped higher on the open, and are up by more than +13.00% on Thursday morning.
This is a 1-month hourly chart by the way.
Let’s look back to the penultimate candle on Wednesday, which as it turns out,does a pretty good impersonation of a bullish engulfing pattern.
True we didn't get confirmation from the final candle of the day, that the bulls were in charge.
Source: Barchart.com
However at 10.51 am on Tuesday morning I had posted the charts below alongside the comment:
“Another one that's hard to love but ...... OCDO LN”
The inference being that on paper, the unprofitable online grocer, shouldn't be attractive.
However, from a technical standpoint there was a lot to suggest a bullish view was the correct one.
Not least the MA crossover on the lower,1-month chart, and the descending downtrend line on the upper 6-month chart.
Source: Barchart.com
Noting the price action, and gathering clues over an extended period, to build up a picture of what's happening and what could happen to a stock price, might seem a bit laborious.
Especially if you are watching a number of stocks, but as you can see from Ocado’s price performance it can be a worthwhile exercise.
For what it's worth I try to keep tabs on as many as 550 stocks in the UK and Europe, and another 700 stocks and ETFs in the USA. It's only possible to do that because I use spreadsheets, stock scanners, alerts and visualisations.
However, the average retail trader should probably have no more than a dozen active stocks, or other instruments in their watchlist to start with.
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