This blog discusses how we use charts and other technical analysis tools in order to gauge market sentiment and garner insight into what market participants are really doing. Survey data, economic data, political events and central bank action are all important factors at a macro level. Company results and guidance on earnings and margins are key for share performance. But when the rubber meets the road, nothing speaks louder than what investors are actually doing. Buying, selling, or holding on for dear life. Any real activity will come through in the market price. If sentiment on the asset is negative, then supply will trump demand until some price level can be agreed on between sellers and buyers. If demand is bigger than supply, the prices will rise as sentiment is positive, until a balance is reached. Simple, right?
As an example, the weekly chart below is Dr Martens, the iconic UK boot maker. There is no doubt that the public loves the style and functionality of the product, and this was reflected in the IPO.
Since this initial euphoria, the market doesn’t like the company’s fundamentals. A story of 3 flat lines on the chart and a missed recovery here lays the groundwork for future downside risk.
The turn below the horizontal yellow line (IPO price) and failed attempt to regain this in late 2021/early 2022 was an important negative chart signal. The turn below the red line shows the 2021 low giving way in early 2022, a big negative signal as well. Finally, the turn below the horizontal blue line in early 2023 broke the 2022 low, and is giving another big negative signal.
Having limited chart history is a problem for chart analysis. This can be addressed by looking at similar companies with more data history and seeing how they are doing, if the view is that this is a sector drawdown. In this case it looks like a company specific negative turn though. The failed attempt to break above the falling green line in late 2022 is worth noting as any investor who took the initial break higher as a reversal of the down trend, quickly rued the day that they were so optimistic.
The white circle shows the ‘miss’ on the downside in October 2022 – the share price could have dropped to test the May 2022 low (blue line) but it didn’t. Buyers stepped in ahead of clear chart support which is a positive event, and a turn above the green falling line (drawn from nearby weekly highs) should have been another positive signal. The fact that it failed was a big bear signal.
Does chart analysis give insight into potential downside risk? A simple extension lower of the height of the congestive zone (green line to blue line) would point towards 80p or so. Bear flags or swing extensions would be just as, or more, bearish. More importantly for optimists though would be to consider what to look for if the share price were to reverse. One could try and put some chips on the table now and then add to this bet if prices fell some more and seek to improve the average price. This works well if the share price does recover and then the investor is a hero. This works a lot less well if the share price continues to dwindle.
Chart fans would need to see 1) higher highs and higher lows and 2) bullish crosses by the price above the moving averages (13 and 50-week moving averages here) and even a ‘golden cross’ (13-week ma above the 50-week ma) in the averages, in order to consider that demand is outstripping supply and the trend may have turned positive. Missing the low is not a sin. A further confirmation of a trend reversal could be breaking above the 2022 low and regaining the late 2022 bounce high. For now, buying the boots may be more popular than buying the share.