Learning How To Read Stock Charts: A Necessity For Successful Stock Trading

June 12th, 2009

As a stock market trader, your business is essentially the buying and selling of stocks, under the principle that you get to buy low and sell high, in order to make a profit. Before you can be successful at this exercise, you need to perfect your knowledge of the stock market. Learning everything you can about how the stock market works and what causes a stock’s price to go up or down, help you trade with the maximum change of making money in the stock market. However, that knowledge is only going to help you if you put it to work by properly conducting market analysis, analyzing stock market charts, and so on.

Since effective and profitable trading is the main factor at determining your success in the stock market, you need to always be prepared as an investor. When you’re performing market analysis (and again, this is one of the most important aspects of the trading process), the effectiveness of your analysis is going to hinge on a few things, not the least important of which is the ability to properly analyze stock charts.

The stock chart can give you some critical information if you know how to read it correctly. Yet the first step of your analysis involves answering a few basic questions: what’s the pattern that’s currently forming in the stock market? Is the chart smooth of is it changing as time goes on? Is there a specific pattern that I can discern by looking at the chart? A pattern that can point me to some valuable information as to which direction the stock is going to take? Once you learn to alter your mindset so that these questions are the ones that come to your mind, then you can say that you have the ability to read a stock chart.

Stock trading, as previously stated, is all about buying and selling stock to make a profit. Simple, but not easy. This seemingly simple process needs good decision-making capability, as well as that invaluable intangible called gut feeling. Sometimes, you also have to be able to spot information that most investors involved in the market might have missed, and when you do, you position yourself to potentially reap substantial profits. That doesn’t mean that you have to be reckless, on the contrary. Sometimes this information that you spot won’t allow you to actually make a lot of money; instead, it might tell you it’s time to sell a particular spot and either secure your gains or avoid losing more money.

So as you can see, knowing how the price of a stock is behaving is essential in making money in the stock market as a trader. Learning how to read stock charts is fairly simple: you collect data (stock prices), and then that data is plotted in different kinds of tables and graphs so that you an see the big picture of what’s happening with a particular stock, group of stocks, or market sector. There are several tools, called technical indicators, that you can use to help you read stock charts.

The science of analyzing and charting stocks is called technical analysis. Some traders choose to base their trading decisions strictly on information they derive from analyzing the charts; those are called pure technical analysis traders and according to them, the chart holds all the information they need to know when it comes to how the stock is going to behave in the future.

What is a stock chart?

A stock chart is simply a graphical representation of a stock’s price over a set period of time. You can see, at a glance, how a stock has performed. There are three (3) basic types of stock charts: bar, line, and candlestick. Which one you use the most will be mostly determined by your trading style. Keep in mind that no matter which type of chart you use, all three basically reflect the same information: the buying and selling patterns of investors.

Key areas of every stock chart

Learning to read a stock chart involves getting familiar with 4 key areas:

Identification section
Time frame
Volume bars
“X” and “Y” axis

Here’s what you’d find in, for example, a Microsoft stock chart:

1.- Identification Section

Company Name: Microsoft Corporation
Trading Symbol: MSFT
Stock Exchange Where Traded: Nasdaq “NAS”
Current Date: (top left corner)
Days Price Change: opening price, day’s price range (high and low), 52-week price range
Main financial ratios: P/E (price over earnings ratio), P/B (price to book ratio), P/S (price to sales ratio)
Volume: how many shares of the stock were traded for the particular time period that’s you’re currently looking at
Market Cap. That’s the total value of the company: price per share multiplied by the number of outstanding shares

2.- Time Frame: the chart will give you a choice of time frames to view (from 1 day to all time), and the choice is yours. It is recommended though that you choose a time frame that fits your trading style. If your trading span is a short term one, you should look at a 3-6 month chart; if you’re more into long term investing, you should analyze a 1-5 year stock chart.

3.- Volume Bars: because the information it tracks is so vital, the volume indicator is often called the heart of the stock market. It’s a key indicator of supply and demand. By looking at the volume bars you can get a good feel for the strength behind the movement behind the stock’s price. Simply put, the more volume, the stronger the movement: a stock moving higher (or lower) on heavy volume is much more likely to continue climbing (or falling) than one that is moving on light volume.

4.- “X” and “Y” axis: the “X” axis is the bottom portion of the graph, running horizontally, and it flows left to right. It’s the portion of the graph that has the time frame that you are looking at. The left side is the past and the right is the present. Use the past as a reference, but trade from the right side of the chart. You trade what you see now.

The “Y” axis is the right side of the chart, running vertically, and flows top to bottom. This portion of the graph reflects the price movements of the stock.

Essentially for the stock market beginner, learning how to read stock charts boils down to three things:

You’re going to look at the correlation between a stock’s price and volume activity (as shown by the price and volume bars).
You’re going to look at the chart and determine if the stock’s price has been trending up or down to decide what action you’re going to take (buy stocks, short stocks, buy call options, or buy put options)
You’re going to determine where the stock’s support and resistance levels are. Support and resistance are areas where the stock has had trouble proceeding past, or an area where the stock halts and changes direction.

As you look through your stock charts, you’ll start developing an eye for interesting trends. Jot down these stocks they’ll become the ones you’ll be watching on a daily basis. You’ll then apply other tools (technical indicators) to the chart to further pinpoint profitable trading opportunities.

Learning to read stock charts can provide you with a wealth of knowledge as long as you know and understand what you’re looking at. Basic charting knowledge combined with other stock indicators can immensely improve your trading skills and help you make more money in the stock market.