Classical Charting Principles
Technical Analysis is, by many sceptics, considered a theoretical approach to markets and not a valid technique to use in practice. Thus, I am writing this article in the hopes of explaining my thought process behind trading decisions made based on my technique of looking at the markets. Classical charting principles (first brought to the world of financial markets by Richard Wallace Schabacker) are based on the actions of market participants ranging from big institutions to small retail traders. It is purely a visual representation of what market participants are thinking and how they are acting.
Classical Charting Principles in Practice
The best way to explain classical charting principles is by providing a detailed and recent example.
So, for this example we have to examine the stock of W&T Offshore, Inc. which is an independent oil and natural gas producer.
W&T Offshore is
engaged in the exploration, development and acquisition of oil and
natural gas properties in the Gulf of Mexico. A few bells should start
to ring when you realize what kind of business they perform…unless
you’ve lived in a cave for the past 5 months?
The stock formed a perfectly structured 1-year long descending triangle on the weekly chart after price failed to break out of a 10-year long descending trend line. These two technical confluences combined with the added problems the COVID-19 crisis would add to oil due to less air traffic and the worldwide lockdowns was the perfect opportunity to short this stock.
A Quick Guide of The Descending Triangle
A Descending Triangle is a bearish chart formation that usually forms as a continuation pattern during a downtrend. There are cases when descending triangles form as reversal patterns at the end of an uptrend, but descending triangles are usually continuation patterns. No matter where they form, descending triangles are bearish and indicate further weakness. Due to its shape, the pattern can also be called a right-angled triangle. Two or more comparable lows create a horizontal line while two or more lower highs form a downward trend line.
Unlike a symmetrical triangle which are classified in the same category, a descending triangle has clear bearish implications before it actually breaks. A symmetrical triangle is a neutral formation and needs a breakout in either direction to indicate the direction of further movement. A descending triangle has a horizontal line that prevents prices from falling. Prices reverse off this level with increased demand and this process can take several weeks or months. Although price does not fall below the horizontal boundary, the chart still prints lower highs. It is these lower highs that indicate increased selling pressure and give a descending triangle its bearish implications.
The Breakout
Soon after spotting the descending triangle prices violently broke out of the descending triangle. How and when you pull the trigger on breakouts, where you place your stops, where you place your targets and how you manage a trade are variables that are entirely based on your own trading style and personal preferences. The choices you have are vast and with a bit of tinkering around you can find a style that matches your personality.
After the Breakout
The trade was a success as prices declined heavily after the breakout of the descending triangle. The oil dispute between Russia and Saudi-Arabia and the subsequent oil crash, which was completely unexpected, added more fuel to the fire which caused the stock of W&T Offshore to free-fall and thus hitting the $2 price target.
This particular example was a rather long term commitment and trading based on weekly charts is usually not something I do often, but there are some opportunities throughout the trading year that I can’t pass up on, this being one of them. Even tough I don’t trade based on weekly charts that often, I chose this example because of the quality and recency of the setup. I hope this has shown you the power of classical charting principles and how you can use these tools to your advantage especially combined with some deeper fundamental due diligence. However, I must warn you that in technical analysis nothing works all the time, so don’t go log in to your broker platform thinking this is the holy grail of the financial markets. Classical charting principles, when used correctly, can provide you with an edge in the markets if you can keep looking for quality setups and at the same time remain consistent in your search for those quality setups.