Episode #5 - Tutorial in Technical Analysis by Alan Hull June 14, 2023

This is another article in a series of education posts from Alan Hull. Alan Hull is a renowned technical analyst within the Australian Market. He has educated thousands of investors on how to apply technical analysis within their overall strategy. In this special series, Alan has agreed to share his Technical Analysis tutorials with Stockopedia members. He has committed to provide one ever three/four weeks. To learn more about Alan you can read his profile here. Or visit his website alanhull.com.au

To re-acquaint yourself with Alan's prior postings, please go to “Discuss” in the left hand column and selecting “Aus/NZBlogs” (see below). Scroll down and you will find a contribution one to every three/four weeks.

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Triangles

‘Points of agreement’ and triangles

During a period of consolation, price activity gradually narrows down over time into what we call a ‘Point of Agreement’ (POA). Thus, if you consider the consolidation pattern in the following chart, you can see how the price activity is spiraling in towards a point. At this point or moment when the market is almost still, near the tip of the triangle, the market participants seem to be content to neither buy nor sell the share.

Hence they are essentially agreeing that the price at which the share is trading at is fair value by refraining from buying or selling it. It would appear the share is no longer a bargain for those who would want to buy it, nor is it selling at a high enough premium for those who want to dispose of it.

The Point of Agreement is at the tip of the triangle, just before the breakout

You’ll also note in this chart that there is a line running along the apex of the triangle and this line identifies the midpoint of the share’s trading range throughout the period of consolidation. In contrast to the ‘Point of agreement’ which occurs at the tip of the triangle, this line is effectively the ‘Line of agreement’.

Anyway, let’s get back to our discussion on market behaviour and the significance of the point of agreement. Of course if a market remained at a point of agreement indefinitely then the market would cease to exist. Hence markets must constantly move in order to survive.

Thus, if everyone agreed on the value or future value of a share, its price would stagnate and eventually the market would dry up and finally dwindle into non-existence. Take for instance the humble $50 note where this would most certainly be the case, if anyone was ever silly enough to try and trade in $50 notes.

Revisiting the example of the $50 note

Not many people would be willing to buy a $50 note for $60. Nor would many people sell one for $40. This is because we all agree a $50 note has a value of $50. Therefore there is no market for $50 notes. Well, the same goes for shares. It is our disagreement about their value that drives the price up and down. Therefore any period of agreement in the market is only ever temporary.

Imaginary Price Chart of a $50 Note

Hence, a period of consolidation can’t persist. The market will eventually break out, either up or down as something will inevitably happen to stimulate it into action. For example; markets revel in news in the short term and can react to anything from rumours to speculation and so it is not surprising that the price will inevitably find a reason to rally and breakout.

The Calm before the Storm

And here’s another way of visualising it; picture in your mind the natural weather phenomenon known as “The Calm before the Storm”. This is when an eerie silence takes hold with little or no wind and there are black clouds on the horizon. The calm feeling is due to warm dry stabilising air produced by the developing storm.

Moisture is removed from the air by developing thunderclouds and the resulting warm dry air circulates back into the vacuum that was initially created in the region around the storm. It is the warm dry air that has a stabilising, settling effect that gives a feeling of calm to the surrounding environment.

My experience with breakouts from consolidation patterns (i.e. triangles) is that the consolidation phase is very much like a calm moment before a storm. But when the breakout does finally happen, it’s usually quite dramatic. Hence the importance of this particular type of pattern.

Triangles

So triangles indicate points of agreement, but with the added advantage that the shape of the triangle can indicate the probable direction of a pending breakout. A downward sloping triangle indicates a likely downward breakout at or near the point where the hypotenuse meets the bottom. Each time the bulls attempt to move the price away from a particular level the bears bring it back. Each time this occurs there are less bulls. When there are no bulls left a downward breakout will most likely occur...

In late 1998 and early 1999 Telstra’s share price enjoyed a meteoric rise that lasted from October 1998 to the beginning of February 1999. The downward sloping triangle gave the earliest warning that the trend was about to end. Note how the price was unable to break away from the $8.80 level.

An upward sloping triangle indicates a likely upward breakout at or near the point of agreement. Each time the bears attempt to move the price away from a particular price level the bulls bring it back. Each time this occurs there are less and less bears. When there are no bears left an upward will most likely occur. Triangles can be big or small…anywhere from 3 bars to 30 bars or even more.

Finally, an equilateral triangle gives no indication as to the direction of the forthcoming breakout but does indicate a point of market agreement and hence a breakout. Thus, market sentiment is not dominant in either direction.

And unlike the previous OLHC bar charts, the following example is a candlestick chart where a chartist will usually place the trendlines against the real bodies of the extreme candles.

Large equilateral triangle in a candlestick chart

I say ‘usually’ because this may not always be the case as in the following example of a triangle pattern. In this instance the lines are drawn using the candlestick shadows as well as the real bodies.

Triangle defined using candlestick shadows as well as their real bodies

So it should be noted that the only hard and fast rule is that when using trendlines to define triangular patterns in candlestick charts, it is essential that the converging lines capture all of the real bodies.

Hence a chartist may choose to include the shadows or to ignore them, depending on the individual circumstance. And so you can now start to appreciate how technical analysis or charting requires the use of discretion. In the next tutorial we’ll look at the special case of horizontal trendlines.

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