Technical analysis as share market shorthand

Almost all technical traders understand the self-fulfilling prophecy inherent in this form of analysis. For example, if traders expect a support level to hold, as the stock’s price action falls toward that level they buy shares in anticipation of a reversal. The increased demand for shares raises the price, causing the very reversal expected.

But technical analysis isn’t only a self-fulfilling prophecy. Because price action reflects the underlying beliefs and expectations of the market’s traders, technical analysis—as reflected by the price movements their actions bring into being—is also a sort of share market shorthand.

In an action called the efficient market hypothesis, technical traders expect the share market to absorb all the data relevant to a company or industry sector, including government regulatory policies and economic and fundamental announcements, as well as earnings, sales, and dividends. All this data is then discounted by the market’s investors into each company’s share price. Because the market’s investors do this absorption process so efficiently, some technical traders see no reason to repeat the process themselves. These are the pure technicians, the traders who utterly ignore fundamentals and concentrate exclusively on their charts.

For traders whose time is at a premium, the purely technical approach has the advantage of requiring less study and research. However, the purely technical approach ignores the signals provided by the fundamental side of the market and therefore can miss some significant trades.

When last analysed, Billabong International Ltd (BBG) had fallen beneath support at 9.25, which then resisted re-testing from beneath, as resistance. The stock entered a new range, with 9.25 as the upper boundary and 8.00 presumably as the new support.

However, four days after that analysis, fundamentals were readjusted during the company’s latest earnings announcement. Net profit through the June quarter decreased 4.5% from year-ago levels, while revenue from operations fell 11.2% and final dividends were lowered from 45 cents per share to 36 cents. Billabong affirmed management had closed a number of stores located in the U.S. and would close others “if they are not contributing.”

Investors absorbed the new fundamentals and decided their shares of BBG were overvalued. With no technical warning, the stock plunged almost 10% to a 52-week low on the next day’s opening, with support at 8.00 giving way as part of a gap downward, as shown on the chart, below:

The gap between 8.74 and 8.09 may join the one dating from March 2009, between 6.36 and 6.49, as a long-term feature on BBG’s chart.

The next support level seems to be at roughly 6.85–6.90. With risk aversion returning to financial markets, if that most volatile month of September doesn’t see the 2009 rally reborn, traders should watch for BBG to roll down to that level.

technical analysis by Craig Liles