Investing in Cannabis: Technical Charts

If you’re serious about investing in cannabis through trading stocks (or ETFs, commodities, or whatever), charts and the related technical data come in handy. Get to know the different types of charts and chart patterns.

Technical analysts use charts to “diagnose” an investment’s situation the same way any analyst uses different tools and approaches. Different charts provide fresh angles for viewing the data. In terms of visualization and utility, the following are the four most common charts used in technical analysis.

Line charts

A line chart shows a series of prices plotted in a graph that displays how the price has moved over a period of time. The period of time can be a day, week, month, year, or longer. The prices usually chosen for a line chart are the closing prices for those market days.

With a yearlong line chart, you can see how the stock has progressed during the 12-month period, and you can do some simple analysis by identifying the peaks and troughs and possibly the strongest and weakest periods of the year for the stock’s price.

Bar/column charts

Bar/column charts are a little fancier than line charts. While the line chart gives you only the closing prices for each market day, the bar/column chart gives you the range of trading prices for each day during the chosen time period. The bar for each trading day shows the stock’s open, high, low, and closing prices.

The difference between a bar and a column chart is that the bars are horizonal in a bar chart and vertical in a column chart.

Candlestick charts

Candlestick charts are tailor made for illustrating movements in stock prices over the course of a day. Each “candlestick” has a “wick” at the top and bottom. The tip of the top wick indicates the high price for the day, and the tip of the wick at the bottom indicates the low price. The top of the candlestick shows the opening price, and the bottom of the candlestick indicates the closing price. If the candlestick is black, the stock’s price dropped from open to close, while if it’s clear (white), the stock’s price increased that day. Note that different colors may be used to indicate whether a stock’s price rose or fell during the day.

Point-and-figure charts

A more obscure chart that technical analysts use is the point-and-figure chart, which contain only Xs and Os. The Xs represent upward price trends, and the Os represent downward price trends. You use this type of chart to identify support levels (below which the stock price may be unlikely to drop) and resistance levels (above which the stock price is likely to struggle) to better judge buy and sell prices.

Identifying chart patterns

Chart patterns are the graphical language of technical analysis, and a very interesting language at that. For technical analysts, the pattern is important because it provides a potential harbinger for what is to come. It’s not 100 percent accurate, but it’s usually accurate better than 50 percent of the time as odds go. In the world of trading, being right more than 50 percent of the time can be enough. Usually, a proficient technician is better than that. The following sections cover common chart patterns.

Technical analysts don’t deal in certainties, they deal in probabilities. Increasing the probability of success for more profitable decision-making (entering or exiting a trade) is the bottom-line mission of technical analysis.

The head and shoulders pattern

The head and shoulders pattern is essentially bearish. It’s usually a signal that an uptrend has ended and the pattern is set to reverse and head downward. Technical analysts consider this to be one of the most reliable patterns.

The pattern shows three peaks and two troughs. The three peaks break down into the tall center peak (the head) and the shorter peaks (the shoulders) that are on either side of the center peak. The two troughs form the neckline.

The head and shoulders pattern tells technical analysts that the preceding trend basically ran out of gas. The selling pressures build up and overpower the buyers. Hence, the price starts to come down. The shoulder on the right is like a last effort for the bullish trend to regain its traction, but to no avail. Keep in mind that the neckline in this pattern is the support (which I discuss in the section, “Looking for resistance and support”). As support is broken, the outlook becomes bearish.

The reverse head and shoulders pattern

The reverse head and shoulders pattern signals that a downtrend has ended and is set to reverse and head upward. In this pattern, you have three troughs and two peaks. The middle trough is usually the deepest one. The small trough on the right is an interim low, which is higher than the middle trough low and typically indicates the trend is moving upward.

In this pattern, buying pressures build up and form a base from which to spring upward. Note that a bullish pattern is a series of higher highs and higher lows. In the reverse head and shoulders pattern, the neckline is resistance. After resistance is broken, the outlook becomes bullish.

The cup and handle pattern

This pattern is generally bullish—the price first peaks then craters into a bowl-shaped trough (the cup), as shown. It peaks again at the end with a small downward move (the handle) before it moves up. This pattern typically indicates that the stock’s price took a breather to build support and then continued its bullish pattern.

The double top and the double bottom

Both the double top and the double bottom chart patterns indicate a trend reversal:

• The double top is essentially a bearish pattern shaped like the letter M, wherein the price makes two attempts (the double top) to break through resistance but fails to do so. The bottom of the trough between the two peaks indicates support. However, the two failed attempts at the resistance level are more significant than the support at the trough, so this pattern signals a potential downturn for that stock’s price.
• The double bottom is the opposite reversal pattern. It’s a bullish pattern shaped like the letter W, with the support level indicators stronger than the resistance (see the following figure). This pattern signals a potential upturn in the stock’s price. Because this indicates a support level, bullish traders tend to look at it as a generally safe entry point to get positioned for the next potential up-move in the stock.

Triple tops and triple bottoms are variations of double tops and double bottoms. These are sideways or horizontal patterns that portend a trend reversal. Don’t even ask about quadruple tops and bottoms!

Triangle patterns

A triangle is formed when the resistance line and the support line converge to form the triangle point that shows a general direction in the stock’s price movement. The indication varies, depending on the shape or orientation of the triangle (see figure):

• Symmetrical points sideways, indicating a horizontal pattern that becomes a setup for a move upward or downward when more price movement provides a bullish or bearish indicator.
• Ascending is a bullish pattern.
• Descending is bearish.

Flags and pennants

Flags and pennants are familiar chart patterns that are short-term (usually not longer than a few weeks, see figure). They’re continuation patterns formed immediately after a sharp price movement, which is usually followed by a sideways price movement. Both the flag and the pennant are similar, except that the flag is in a channel formation, whereas the pennant pattern is triangular.

Wedges

The wedge pattern can be either a continuation or reversal pattern. It seems to be much like a symmetrical triangle, but it slants (up or down), whereas the symmetrical triangle generally shows a sideways movement. In addition, the wedge forms over a longer period of time (typically three to six months).

Gaps

A gap in a chart is an empty space between two trading periods. This pattern occurs when the difference in the price between those two periods is substantial. Say that in the first period, the trading range is $10 to $15. The next trading session opens at $20. That $5 discrepancy will appear as a large gap between those two periods on the chart. These gaps are typically most noticeable on bar and candlestick charts. Gaps may happen when positive (or negative) news comes out about the company, and initial buying pressure causes the price to jump in the subsequent period as soon as markets open.

Gaps come in three flavors: breakaway, runaway, and exhaustion. The breakaway gap forms at the start of a trend, the runaway gap forms during the middle of the trend, and the exhaustion gap forms as the trend fizzles.