THE RIGHT WAY TO READ THE CHARTS
Every technical analyst has to go thru the grind. It doesn’t matter what the starting point was- a book, a course, a video, and a talk- that was just to spark the interest. It creates the desire to learn, to know, to apply, to profit. Then begins the journey. Those that are impatient with the learning process and want to accelerate to the earnings cut short their journey- confining it to what they believe “works”. They come to this conclusion on some hasty or shabby process of elimination. To their own discomfiture, this seldom works. Two things happen then- many give up, saying this ‘doesn’t work’ while a few others are able to say ‘maybe I didn’t know enough to make it work’. That latter group hits the drawing board again, this time a bit more serious about the learning process.
Eventually, you finish the learning to some extent and now are ready to take the plunge. Into the world of trading and investing or into the world of advising others. Then start the difficulties. But now, instead of retreating, you will start rising to the challenge of solving them. One way to solve them would be to get more learning, more knowledge; another way would be to improve implementation and usage. The former is easier to solve, as external resources are available. The latter requires you to make adjustments to the way you are working.
Each one of us is infinitely capable of working better, achieving more. In the words of the great athlete Michael Phelps, “the only limits we face are the one that we impose upon ourselves”. So the adjustment you have to make is to remove the limits that we place on ourselves. Easier said than done, of course. But we have to do this- because, in the markets, no one else can do it for you.
Let’s use analysis and action as an example. We look at charts and come up with signals and estimate the outcome of those signals. And we make our play based on that. From 40 years of doing just this, I have come to some realisations and I am jotting down a few.
a. All signals have the same value. They differ in outcome only based on the context in which those signals appear.
b. It is therefore more important to identify the context in which signals are emerging than to spend all the time identifying the signal itself.
c. Every context has multiple correlations with other elements. The impact of the signal will be a function of the net sum of all those correlations.
One has to understand this aspect of analysis to know the difference in the way signals morph into results. The same signal that worked brilliantly last time fails to do so this time. Or has only a limited impact. History does repeat but never quite exactly. That is because events repeat but the context in which those events occur are seldom the same and hence the result is never the same. To understand and accept that any signal has the same value irrespective of the time frame of the chart is a difficult notion to accept. When we learn TA thru the books and courses, we are told and we see too that breakouts on intraday charts are quite different in impact from breakouts that occur on weekly charts. But, and this is an important distinction, the signal is the breakout and that is always the same no matter whether it is in an intraday chart or a weekly chart. The technical signal is Breakout. The impact and the outcome of a technical signal is Contextual.
Similarly, a support or resistance is just that- an area of increased demand or supply. Through retests, the value of the support or resistance gets enhanced. But whether it shall hold or not in future depends on the context in which the prices are approaching the same area once again.
So, if we do not make an effort to understand the context, then we may not succeed in being able to forecast very accurately. It will then become a hit and miss story. Not good if you want to be a successful anything in the market.
Context is created by just about everything. But most of the time it is created by news and events. Hence there has to be an awareness of the current news and events surrounding the market. That means the stock and the sector. Next would be the current sentiment. It is common knowledge that bullish signals fail in bearish markets and vice versa. Why is that? Mainly, because of sentiment. Currently, for example, the market is caught in a somewhat despondent mood. Owing to this, average results are ignored and only exceptional results get the stock price moving higher. Poor numbers see stocks getting thrashed. Move back two years, to 2017 and the scene was exact opposite. The sentiment was so buoyant that people were not too concerned about details. Just a few lines of story were sufficient- and people were ready to pounce on the stock and take it higher. The quantity they bought was also substantially larger- which in turn impacted the stock moves further. So it became a virtuous cycle that kept feeding on itself- until one day it stopped!
Hence we need to take the technical signal- say, a breakout- and place it in the context of the stock, the sector, the kind of players who are active in the stock (like retail or Hni or Institutions etc.), the liquidity or lack of it etc. etc. Then we take all this and feed into the arbiter of sentiment to see whether the response shall be light or exaggerated. Thus we get an idea of what can be possible.
What can be and what is shall be two different things of course! We don’t know, for example, how much of the context is already in the prices- the common phrase for this in the market is ‘what is baked into the cake already’. If the market already has a wind of it then the reaction will be muted. But if the market gets caught by surprise, as happens sometimes, then the response is exaggerated. We can often see this play out during results season. Good numbers are many times followed by declines and people are mystified. That is mainly because the market was already aware that good numbers would be flashed by the company. The times when good numbers take prices up is when those numbers are ahead or way beyond what had been factored by analysts beforehand. So there is a rush to review their models and fresh targets are flashed and fresh buying activity occurs. The situation is similar with other news items also. The only way for us to know what the market already knows is thru the response of the prices. Hence my oft made statement, it is not the news that is important but the market’s response to the news that is important.
Remember that we have to respond and act to what is and not what should be. Fundamental analysis concentrates more on what should be. Value investing focuses on what should be after a long period of time. Both choose to disregard what is in favour of what should be, believing that their version of the future shall unfold. This is referred to as ‘conviction’ in your belief about the future of the stock. That is fine as long as it works and in hindsight you will be seen as a great investor. However, there are only a few who have the necessary access, the requisite abilities and needed staying power to hold on to that conviction. For the rest of us, there is only Hope. And hope is never a good investing or trading strategy. Hope is more of a loser strategy.
It is only technical analysis that addresses the ‘what-is’ and also gives you a ‘what-could-be’ situations. Trouble is when one cannot map or structure the ‘what is’ in the proper way. There is too much noise happening in the present and that colours the judgement of ‘what-is’. This is the hard part that has to be learnt, how to keep the noise aside while reading the data. To the level that one is successful in doing it, the reading of the market becomes so much clearer.
Charts lend a measurable character to the context (which is always all around us) and helps us to frame market moves in a manner that makes it more predictable and thereby increase the probabilities of being successful with our forecasts. Combining charts with context (to the max extent possible) is the best way forward. Every time one sees a signal emerge on the chart, one must always ask the question, what is the current context under which the signal is being generated? And attempt to answer that question in full.
If one moves ahead this way chart reading will improve considerably and so will our success in the markets.