Technical analysis for beginners: ChartWatch Primer

Many of you clicked on this article because you are following my ChartWatch Scans series that I publish each morning before the open of the ASX. In ChartWatch Scans, I display lists of my favourite uptrends and favourite downtrends based on my technical analysis model.

I have been developing this model for over three decades, and it has been honed through bull markets, bear markets, and everything in between. There are many technical analysts and many technical models out there, and I encourage you to investigate widely within this genre. I can say with absolute confidence however, that my model is one of the simpler ones you’ll find – so if you’re looking for dozens of squiggly lines and plenty of colourful arrows, you’ve come to the wrong place!

Demand versus Supply equals Price

My entire model is based on this basic tenet of economics. When demand for an asset is greater than its supply, all things being equal, the price of the asset will rise. Conversely, when supply for an asset is greater than its demand, all things being equal, the price of the asset will fall.

Any technical analysis method or indicator that does not have this tenet at its heart, is in my experience little more than fluffy window dressing. There is of course volume, the other key and non-price related data input, that helps a technical analyst determine the relative flow of demand and supply.

In my experience, simple is best. Both in terms of effectiveness, but also in terms of ease of implementation. A model that is easy to understand is easy to implement, is therefore easier to stick with. I want users to really understand my model, and more importantly, I want them to see it working in practice.

The reason I share my model is because I’ve made many mistakes over my investing journey, and in many cases, those mistakes caused me great pain. But, as with anything else, you must make mistakes to learn the right way to do something. Often the right way is simply doing the opposite of the thing that caused you pain in the first place!

By sharing my technical model here, in my work on Market Index and Livewire, and across my socials, I hope to help other investors avoid some of the mistakes (and pain) I endured early on – so that they can achieve their investing goals safer and faster.

My aim in writing this article is to create a ready reckoner for those looking to use the ChartWatch Scans Lists, as well those who wish to follow my other regular technical analysis across the Market Index and Livewire sites.

It all starts with trend following

Trend following is a technical analysis method that seeks to identify and then trade in the direction of the trend. A trend can be described as a pervasive movement in a stock’s price over time. Trends can be up, down, or sideways, and trend durations can last anywhere from minutes to years.

Periodicity

It is important to select a periodicity carefully (i.e., the amount of time applied to each session/bar/candle on one’s chart). Your periodicity should be consistent with your trading style and goals. This means that if you are a shorter-term trader, for example, a day trader, you may wish to choose between periodicities ranging from ticks, minutes, and up to hourly candles. 

Medium to longer term investors on the other hand, are likely better suited to daily, weekly, or monthly candles. Personally, I prefer to use daily candles because they give me the flexibility to respond to short term price fluctuations, but not so quickly that I am jumping at noisy intraday moves.

Excess demand/supply creates trends

Whatever one’s method of identifying the trend, the trend follower must then only trade in the direction of that trend. This means only looking to buy stocks in uptrends and only looking to avoid, sell, or short sell stocks in downtrends.

It’s worth remembering here, that all price discovery and price movement occurs because of the interaction between demand and supply. Rising trends are consistent with excess demand, or as I prefer, with “demand-side control”. Conversely, falling trends are consistent with excess supply, or as I prefer, with “supply-side control”.

So, when one buys into an uptrend, one is hoping the prevailing environment of demand-side control will continue to push the price higher. Similarly, when one is short selling into a downtrend, one is hoping the prevailing environment of supply-side control will continue to push the price lower.

The future is unknown

This brings me to the most important point I will make in this article:

The future is unknown. My brand of technical analysis can only tell you what has happened, it does not and can not tell you what is going to happen – that is impossible. My model assumes that the prevailing trend will continue. If it doesn’t, one may well lose money, but this is part and parcel of investing.

Every investment should have attached to it an exit methodology. Ideally, this is also technically based, and I simply use the opposite of what got me into an investment as the trigger for getting me out.

When an investment does not go as desired, it is exited with ruthless, emotionless efficiency, and the model is used to find the next investment.

ANALYSE. INVEST. ANALYSE. EXIT. ANALYSE. INVEST. ANALYSE. EXIT...REPEAT!

There is no place for emotions in investing, and one should execute their model as if they were a pilot checking boxes in a pre-flight routine.

Candles

For me, candles represent the atoms of my technical methodology. They are the most basic building blocks in helping me understand the interaction between demand and supply.

Candles consistent with demand-side control (i.e., “demand-side candles”) are those with white bodies (i.e., the box part of the candle) and or downward pointing shadows (i.e., the line part of the candle).

Typical demand-side candles

Candles consistent with supply-side control (i.e., “supply-side candles”) are those with black bodies and or upward pointing shadows.

Typical supply-side candles

Before buying a stock, I prefer to see a predominance of demand-side candles, this means a greater relative number of demand-side candles compared to supply-side candles, but also a generally greater size of demand-side candles relative to supply-side candles.

The opposite is true for avoiding, selling, or short selling a stock. I prefer to see a predominance of supply-side candles (again, greater in both number and relative size).

Price action

Price action describes the movement of price over time and can be considered on a single candle basis (i.e., intraday price action), and over many candles. For the latter, the most important to me is the relative position of price action patterns commonly referred to as “peaks” and “troughs”.

A peak is a local high point; it is the highest point between a period of rising session highs and session lows and a period of falling session highs and falling session lows. Peaks are shaped like the letter “A”.

Typical point of supply (peak)

A trough is a local low point, it is the lowest point between a period of falling session highs and session lows and a period of rising session highs and rising session lows. Troughs are shaped like the letter “V”.

Typical point of demand (trough)

More accurately, each peak represents a historical “point of supply” – it is where the demand-supply environment shifted from a state of excess demand to a state of excess supply. Similarly, each trough represents a historical “point of demand” – it is where the demand-supply environment shifted from a state of excess supply to a state of excess demand.I believe points where shifts in the demand-supply environment occurred are important because they represent a shift in the perception of value for the underlying asset.

For example, if a point of supply is not breached, but rather it is reinforced, it demonstrates growing supply. If the price should then breach its last point of demand, it would indicate demand removal. The combination of supply reinforcement and demand removal is consistent with supply-side control. For this reason, I associate falling points of demand and falling points of supply with supply-side control.

Falling points of demand and falling points of supply indicate supply-side control

Also consider, if a point of demand is not breached, but rather it is reinforced, it demonstrates building demand. If the price should then breach its last point of supply, it would indicate supply removal. The combination of demand reinforcement and supply removal is consistent with demand-side control. For this reason, I associate rising points of demand and rising points of supply with demand-side control.

Rising points of demand and rising points of supply indicate demand-side control

The practical application of my price action theory is this: Before buying a stock, I prefer to observe rising points of demand and rising points of supply, that is, price action consistent with demand-side control; and before avoiding, selling, or short selling a stock, I prefer to observe falling points of demand and falling points of supply, that is, price action consistent with supply-side control.

Trends

The final tent peg of my technical analysis methodology is trend. I prefer to consider short term (ST) and long term (LT) trends. To do this, I use my trend ribbons. My trend ribbons are two sets of moving averages: 21-34 durations for the short term trend and 144-233 durations for the long term trend. (Note: I use a few secret herbs and spices to make them change colours at the appropriate times!)

My trend ribbons serve two critical purposes:

1. To quickly identify the direction of the relevant trend (ST: light green up, orange neutral, light pink down; LT: dark green up, orange neutral, dark pink down).

2. To identify potential zones of “dynamic” demand and supply.

On the first point, the trend ribbons quickly summarise the price action created by the candles and peaks and troughs so that in one glance (i.e., without meticulously analysing individual candles and the relative position of peaks and troughs), I can ascertain the direction of a relevant trend.

Trend ribbons in action (click here for full size image)

This ease of use allows me to quickly scan through a watchlist of hundreds of charts very quickly (think of less than a second a chart), retaining only candidates with the appropriate trends, and discarding those without. It takes time to consider candles and price action, so I want to do this in the next step on as small a list as possible.  

As for what I am looking for, this is very straightforward: I prefer to buy stocks that are showing ST and LT uptrends, and avoid or sell stocks that aren’t. I prefer to short sell stocks that are showing ST and LT downtrends.

The second critical purpose of my trend ribbons is to identify potential zones of dynamic demand and dynamic supply. I have already discussed the concept of peaks and troughs as points of demand and points of supply respectively. Think of these as “static” points of demand/supply.

My trend ribbons are always moving with the price – they are dynamic. I have found that in an uptrend, the price will often bounce out of the trend ribbons in an upwards direction, therefore providing a zone of “dynamic demand”. 

Dynamic demand in action (click here for full size image)

Similarly, I have found that in a downtrend, the price will often bounce out of the trend ribbons in a downwards direction, therefore providing a zone of “dynamic supply”.

Dynamic supply in action (click here for full size image)

This means that I can use a close below my uptrend ribbons as a trigger to say that the relevant uptrend has ended for the time being, and similarly, a close above my downtrend ribbons as a trigger to say that the relevant downtrend has ended for the time being.

As for defining trend change, well this bit is super important: Waiting for the trend ribbons to change colour (i.e., the traditional "cross over" to indicate a change in direction) takes too long! This is a flaw in many trend following systems based on moving averages.

For me, a trend change from down to up occurs when a trend ribbon transitions from offering dynamic supply to dynamic demand, and a trend change from up to down occurs when a trend ribbon transitions from offering dynamic demand to dynamic supply. This makes my trend ribbons far more responsive to changes in price action than traditional moving average based trend following systems.

Carl’s Technical Analysis Method Checklists

Buy Checklist

⏹️ Predominance of demand-side candles

⏹️ Rising points of demand and rising points of supply

⏹️ ST uptrend

⏹️ LT uptrend

⏹️ Dynamic demand is being respected

Short Sell Checklist

⏹️ Predominance of supply-side candles

⏹️ Falling points of demand and falling points of supply

⏹️ ST downtrend

⏹️ LT downtrend

⏹️ Dynamic supply is being respected

Closing thoughts

These are the basics of my technical analysis methodology. It is my experience that ticking all the boxes relating to candles, price action, trend, and dynamic demand/supply, contributes to better investing outcomes. This means that if I can’t tick all the boxes on the way in – then I don’t get in.

As time goes by, if an investment starts to lose checks from the relevant boxes, there is a strong chance the demand-supply environment is shifting away from favouring that investment. When this occurs I don’t ask questions, I just get out.

There are no guarantees with any investing methodology – technical, fundamental, or otherwise – and I cannot promise you that using my methodology will result in profits every time. I can say with confidence, however, that over many years – this methodology has worked well for me.

Note, there’s more to my model than requires mentioning in a Primer, particularly concepts relating to volume and volatility. Also, there are other factors relating to capital and portfolio management that are critical to long term investing success. If technical analysis is the tool I use to determine what and when to buy and sell, then my capital and portfolio management helps me determine how much to buy and sell. I feel these factors are substantially more important than the basic consideration of stock selection we have discussed here.

Finally, consider that mine is a purely technical approach with zero consideration of a company’s fundamentals, microeconomic, or macroeconomic factors. I believe all relevant available information is consumed and acted upon by the demand side (i.e., those with cash) and the supply side (i.e., those with shares), and that both sides make informed and rational decisions. This means: Everything I need to know is in the price.

My methodology suits my belief system, and so I am better equipped to follow it meticulously and with great discipline. You should choose the methodology that suits you best, and that allows you to follow it with great discipline. I hope that by writing this article I have brought technical analysis and trend following to your attention, and that it may also become part of your investing approach.