Using Technical Analysis As A Risk Management Tool: 4 Examples

- March 01, 2020

I happened to be online last week, following some of my global peers and again noticed something that has been a recurring feature: even the most experienced and well-respected technical analysts still have a tough time in selling the discipline as a viable tool in financial markets. Yes, there are are myriad of ways to make money in the market, which includes Fundamental, Quantitative, Quantamental and many more but when it comes to technical analysis there is often a great deal of doubt that the outcome is less reliable than most other forms of analysis. Peter Brandt, who has been in the business for 45 years is one of the gentlemen who has been successful but is still doubted, while J.C Parets, who services hedge funds and other institutions ofetn describes how thought of as 'voodoo' by the rest of the market. One of my acquaintances who previously traded at a large boutique asset manager and now works as a hedge fund manager, describe to me how Technical Analysis is considered a 'dirty word' within the investment industry but that fund managers continue to still watch the charts. My belief is that ignoring TA is akin to not checking your car's brake pads every once in a while. While the fuel gauge is most watched, and the gear box is most mostly used, the brake pads still serve as an important feature of the journey and would prevent you from seeing a major accident occur.

Using Technical Analysis As A Risk Management Tool: 4 Examples

With the financial markets having wiped off nearly $3.5 trillion this past week and the JSE having lost 7200 points or 13.6%, it was the useful of technical analysis or strategy that played a part in helping us manage risk and avoid the large fall in the JSE. By recognizing that the Top 40 Index was developing a similar chart structure to a prior period (August 2018), it was highly probable that the a similar fall could take place. Subsequently we saw a fundamental catalyst emerge in Coronavirus which prompted widespread selling pressure both locally and global. This is illustrated by the original post both on our client platform as well as a tweet I had posted 6 weeks ago 20 January 2020:

My second example of how technical analysis helped manage risk was my October 2016 sell call on JSE technology company, EOH. I was reminded of it this week as I was required to make a media comment as the share has been languishing at a multi-year low close to 400c. This is astonishing because in October 2016 the company was considered a market darling who was beating analyst earnings estimate every six months and was seen as the ultimte growth stock. While the market cheered the share, my review uncovered 'technical' or 'chart' risk close to the all time highs at a price of R166. This prompted me to make a SELL call at the height of the share's popularity, which in hindsight was the right call.

EOH Share Price Since My Sell Call:

Thirdly, I was hit with a question on one of my technical calls: a pairs trade idea suggesting Long Sasol/Short Sibanye. Posting it on Twitter, one of my followers asked: "what are you smoking?". I was dying to react but rather ignored out of professionalism and courtesy. Since the post, which was just over 11 days ago, the pair has gained 23% in a market that was down by 13%, that's a 36% out-performance! My rationale behind the idea was based on a mean-reversion strategy as well as additional technical factors.

Last but not least is one of my favourite calls in recent times. In November 2018, Discovery CEO Adrian Gore appeared on the cover of the Sunday Times/Business Times having received a Lifetime Achievement Award. No doubt, the man is a business icon, having grown the company from a small player in 1992 to one of South Africa's most innovative financial services groups. In recent years, the foray into China (via Ping An) as well as the launch of the new bank has excited investors greatly, pushing the share to 193 at it's peak. Technically, the share starting signalling risk in October 2018 with my final sell call taking palce at 161.08 in November 2018. Since then we have seen the price trading below R100, with directors hedging their positions via exotic derivative structures to protect existing holdings. Below are my screenshots from the Twitter platform, posted in October and November 2018 as well as the chart trajectory since.