Understanding Supply and Demand Dynamics WILL lead to Profits
Technical analysis has a bad reputation and I can understand why. Most technical analysts do not seem to understand the basics. To make matters worse, some analysts discuss esoteric techniques such as Gann Theory, Harmonic Patterns, or Elliot Waves. In my opinion these is no validity to these methods. They are in the realm of the Loch Ness Monster and UFOs. They are fun to talk about, but are not real. Professional institutional traders do not pay attention to them.
In financial markets, there are certain price levels that are more significant than others with regards to the amount of supply and demand that exists at them. In addition, prices are always doing one of three things. They are either going up, going down, or staying the same.
When understood and applied correctly, technical analysis is an illustration of these dynamics. This can lead to profits!
As someone who traded in the hedge fund world for more than twenty years, I can tell you first hand what the pros do care about. Important support and resistance levels, trends, momentum and risk management.
Let’s take a look and some of the dynamics that are occurring in the marijuana stocks. Knowing where the important levels and trends are can help you develop trading ideas. It can also help you decide at what levels to place your buy and sell orders and whether you should use market or limit orders.
Aurora Cannabis Inc. (TSE:ACB) grows and sells cannabis.A lesson to be leaned here is how resistance levels become support levels.
You can see that in early November and then again in early February that the $10.30 level was resistance. It was also resistance in mid-March for a week before it was broken to the upside.
In mid-May, ACB found support around $10.30 and rallied. This level is currently being tested again. A resistance level has become a support level. How does this happen?
Well…the people who sold their stock at $10.30 were feeling pretty good when it went lower, but after it broke the level and went higher they tell themselves that they have made a mistake selling it. If it ever comes back down to $10.30 they will buy it back.
The short-sellers are losing money after it trades higher and they tell themselves that if it gets back to $10.30, they will cover and break-even.
The people who bought ACB at $10.30 have seen a profit. They tell themselves that if the stock trades back down to $10.30 they will buy more.
So now we have three different types of interested buyers. Add to that the professional traders who see these levels and trade accordingly and you can understand why resistance levels become support levels.
Trulieve Cannabis Corporation (TSY:TCNNF) provides medical cannabis products.
Here we see a classic ‘Head & Shoulders’ pattern. Like most things in technical analysis, this pattern is largely misunderstood.
It is important to understand that you can’t just mindlessly look for patterns and be successful. You need to understand the supply and demand dynamics that these patterns are illustrating.
First of all, this type of pattern is a Reversal Pattern. That means that it can only come at the end of a long and meaningful uptrend or downtrend. If an analyst claims to see a H&S pattern as a continuation of the trend, they are wrong. At least by a classic definition.
Second, if an analyst claims to see a H&S when the market is trading sideways they are wrong as well.
Here we have a perfect H&S. The left shoulder formed after the stock doubled in two months. This is clearly a trend.
In a H&S, the Left Shoulder illustrates the ‘smart money’ starting to sell. After the stock falls and rallies back, the ‘smart money’ completes their selling during the Head. The most amount of volume usually happens in the Head, like we see here.
At this point there is only minimal buy interest. There is one last gasp on lower volume during the Right Shoulder before he price falls dramatically due to the lack of buy interest.
If this plays out as it usually (not always) does, the Neckline, or support at $11, should break and we will see a large selloff.
Innovative Industrial Properties Inc. (NYSE:IIPR) buys industrial properties and rents space to cannabis growers.
There are a of couple lessons to be learned here. It was first clear that there was resistance at $90 in March. Since then that has been the top of the range.
IIPR has since formed a Rectangle Pattern. This is simply a pattern that illustrates consolidation or sideways trading. This is clearly defined support at the bottom of the range and clearly defined resistance at the top.
Knowing that the stock is range-bound means that making a decision immediately on whether to buy or sell isn’t pressing. There is still time to perform more research and analysis because the price isn’t going anywhere in the immediate future.
This is an example where a Logarithmic chart should be used. Logarithmic charts are shown in percentages as opposed to dollar figures. For example, a 10% move will appear to be the same magnitude as if it is from $10 to $11 or $500 to $550. On a standard chart the latter would look like a much larger move.
When looking at a long timeframe and a very wide price range, such as is the case here, this type of chart will give a more accurate picture than a standard chart will.
Kushco Holdings. (TSE:KSHB) makes packaging products for the cannabis industry.
KSHB is the most oversold that is has been in a year. What does oversold mean? It is simply a measurement of how far away today’s price is from the price X days ago. It is a measurement of momentum.
Many traders look at numerous momentum indicators. There is really no reason for this, as they are all different ways of measuring the same thing. My advice is to just pick one or two and master them.
How can a trader profit by this knowledge? When markets are overbought and get to resistance they tend to revert. When markets are oversold and get to support they tend to revert.
Here we have a market that is very oversold and at support. There is a chance that we may see a significant rebound.
The important thing to remember is don’t try to catch the exact bottom. A better strategy is to buy it after the downtrend line is broken and it is on the way back up. This helps ensure that the forces of demand are back in control.
You wont get the exact low price but the risk reward ratio is better than trying to catch a ‘Falling Knife’.
Tilray Inc. (NASDAQ:TLRY) researches, grows, and sells cannabis.
Tilray clearly illustrates the concept of a trend. Unfortunately for TLRY shareholders, it has been a downtrend.
Understanding trends and trend-lines is not complicated and it can be tremendously helpful.
In markets prices are always going up, down, or staying the same. We they are going up the forces of demand are in control. When they are going lower the forces of supply are in control. When they are trading sideways the forces of demand and supply are equal.
As we can see here, since September the forces of supply have clearly been in control. The stock has fallen about 70% since then. One reason could be due to the fears about the concentrated ownership.
Privateer is a Private Equity fund. They own an astonishing 75 million shares out of the 80 million total shares that are outstanding.
If Privateer ever decides to sell their stock they are going to have very hard, if not impossible task. When a shareholder owns 90% of a company and word gets out that they are selling, smart investors won’t touch it. TLRY could conceivably be a single digit stock.
Medicine Man Technologies Inc. (NASDAQ:MDCL) grows and sells medicinal and recreational cannabis.
The Symmetrical Triangle pattern that we looked at last week played out exactly as expected. Now it appears as though there is another lesson the be learned from MDCL, and this is the concept of a Reversal Pattern.
When understand, reversal patterns are easy to recognize. It is not important to remember all of the names of reversal patterns. It is important to understand what they illustrate.
Aptly named Reversal Patterns indicate that the trend may be reversing. They display a shift in the supply and demand dynamics.
Let’s take a look at this pattern. The bottom of the blue candlesticks shows the opening price and the top shows the closing price. On blue days demand is in control.
Red days are the opposite. The top of the candlestick is the opening price and the bottom is the close. Supply forces are in control.
Here we see that from May 20th to May 28th, everyday was a blue day. Demand was in control. Then starting May 29th we see three red days in a row. That means that the forces of supply may have taken control and they may drive the stock into a new downtrend.
I don’t know the name of this Candlestick Pattern, but I can almost guarantee that it has one.
Scotts Miracle-Gro Company (NYSE:SMG) manufactures and sells systems and accessories for hydroponic gardening.
We can see here how markets do in fact have long-term ‘memories’. One year ago, the $87.50 level was a clear resistance level from May through July.
Here we are one year later and this level has become a support level. Why does this happen?
The people who sold it e last year were happy until last month when it traded above back above the level. They tell themselves that they made a mistake selling it there, and if the stock gets to $87.50 they will buy it back.
Those who went short last year were looking at a profit for 11 months. Then last month they started losing money. They tell themselves that if the stock gets back to $87.50 they will cover their shorts and breakeven.
Those who bought SMG at $87.50 were underwater for a long-time, but then after the trade finally becomes profitable they tell themselves that if the stock gets back to $87.50 they will buy more.