|Beginners Guide to Stock Market Price Charts & Technical Analysis
New to Trading and Technical Analysis? Learn the Basics of Stock Charts
|Stock charts gained popularity in the
late 19th Century from the writings of Charles H. Dow in the
Wall Street Journal. His
comments, later known as "Dow Theory", alleged that
markets move in all kinds of measurable trends and that these
trends could be deciphered and predicted in the price movement
seen on all charts.
FUNDAMENTAL ANALYSIS seeks to
determine future stock price by
understanding and measuring the objective "value" of
an equity. The study of stock charts, known as TECHNICAL
ANALYSIS, believes that the past action of the market itself
will determine the future course of prices.
A stock chart is a simple two-axis
(x-y) plotted graph of price and time.
Each individual equity, market and index listed on a public
exchange has a chart that illustrates this movement of price
over time. Individual data plots for charts can be made using
the CLOSING price for each day. The plots are connected together
in a single line, creating the graph. Also, a combination of the
OPENING, CLOSING, HIGH and/or LOW prices for that market session
can be used for the data plots. This second type of data is
called a PRICE BAR. Individual price bars are then overlaid onto
the graph, creating a dense visual display of stock movement.
Stock charts can be created in many
different time frames. Mutual
fund holders use monthly charts in which each individual data
plot consists of a single month of activity. Day traders use 1
minute and 5 minute stock charts to make quick buy and sell
decisions. The most common type of stock chart is the daily
plot, showing a single complete market session for each unit.
Stock charts can be drawn in two
different ways. An ARITHMETIC
chart has equal vertical distances between each unit of price. A
LOGARITHMIC chart is a percentage growth chart. It has equal
vertical distances between the same percentages of price growth.
For example, a price movement from 10 to 20 is a 100% move. A
move from 20 to 40 is also a 100% move. For this reason, the
vertical distance from 10 to 20 and the vertical distance from
20 to 40 will be identical on a logarithmic chart.
Stock chart analysis can be applied
equally to individual stocks and major indices. Analysts
use their technical research on index charts to decide whether
the current market is a BULL MARKET or a BEAR MARKET. On
individual charts, investors and traders can learn the same
thing about their favorite companies.
Use the stock chart to identify the
current trend. A trend reflects
the average rate of change in a stock's price over time. Trends
exist in all time frames and all markets. Day traders can
establish the trend of their stocks to within minutes. Long term
investors watch trends that persist for many years.
Trends can be classified in three
ways: UP, DOWN or RANGEBOUND.
In an uptrend, a
stock rallies often with intermediate periods of consolidation
or movement against the trend. In doing so, it draws a series of
higher highs and higher lows on the stock chart. In an uptrend,
there will be a POSITIVE rate of price change over time.
In a downtrend, a
stock declines often with intermediate periods of consolidation
or movement against the trend. In doing so, it draws a series of
lower highs and lower lows on the stock chart. In a downtrend,
there will be a NEGATIVE rate of price change over time.
Rangebound price swings back and forth
for long periods between easily
seen upper and lower limits. There is no apparent direction to
the price movement on the stock chart and there will be LITTLE
or NO rate of price change.
Trends tend to persist over time. A
stock in an uptrend will continue to rise until some change in
value or conditions occurs. Declining stocks will continue to
fall until some change in value or conditions occurs. Chart
readers try to locate TOPS and BOTTOMS, which are those points
where a rally or a decline ends. Taking a position near a top or
a bottom can be very profitable.
Trends can be measured using
TRENDLINES. Very often a straight
line can be drawn UNDER three or more pullbacks from rallies or
OVER pullbacks from declines. When price bars then return to
that trendline, they tend to find SUPPORT or RESISTANCE and
bounce off the line in the opposite direction.
A famous quote about trends advises
that "The trend is your friend". For
traders and investors, this wisdom teaches that you will have
more success taking stock positions in the direction of the
prevailing trend than against it.
|Volume measures the participation of
the crowd. Stock charts display
volume through individual HISTOGRAMS below the price pane. Often
these will show green bars for up days and red bars for down
days. Investors and traders can measure buying and selling
interest by watching how many up or down days in a row occur and
how their volume compares with days in which price moves in the
Stocks that are bought with greater
interest than sold are said to be under ACCUMULATION. Stocks
that are sold with great interest than bought are said to be
under DISTRIBUTION. Accumulation and distribution often LEAD
price movement. In other words, stocks under accumulation often
will rise some time after the buying begins. Alternatively,
stocks under distribution will often fall some time after
It takes volume for a stock to rise
but it can fall of its own weight. Rallies
require the enthusiastic participation of the crowd. When a
rally runs out of new participants, a stock can easily fall.
Investors and traders use indicators such as ON BALANCE VOLUME
to see whether participation is lagging (behind) or leading
(ahead) the price action.
Stocks trade daily with an average
volume that determines their LIQUIDITY. Liquid
stocks are very easy for traders to buy and sell. Illiquid
stocks require very high SPREADS (transaction costs) to buy or
sell and often cannot be eliminated quickly from a portfolio.
Stock chart analysis does not work well on illiquid stocks.
Breakouts accompanied by volume much
higher than the average for that stock are
healthy for the continuation of the price movement in that
direction. But after long rallies or declines, stocks often have
a day of very high volume known as a CLIMAX. During these days,
the last of the buyers or sellers take positions. The stock then
reverses as there are no longer enough participants to cause
price to move in that direction.
|Patterns and Indicators
|How can you organize the endless stream
of stock chart data into a logical format that
doesn't require rocket science to interpret? Charts allow
investors and traders to look at past and present price action
in order to make reasonable predictions and wise choices. It is
a highly visual medium. This one fact separates it from the
colder world of value-based analysis.
The stock chart activates both
left-brain and right-brain functions of logic and creativity. So
it's no surprise that over the last century two forms of
analysis have developed that focus along these lines of critical
The oldest form of interpreting charts
is PATTERN ANALYSIS. This method
gained popularity through both the writings of Charles Dow and Technical
Analysis of Stock Trends, a classic book written on the
subject just after World War II. The newer form of
interpretation is INDICATOR ANALYSIS, a math-oriented
examination in which the basic elements of price and volume are
run through a series of calculations in order to predict where
price will go next.
Pattern analysis gains its power from
the tendency of charts to repeat the same bar formations over
and over again. These patterns
have been categorized over the years as having a bullish or
bearish bias. Some well-known ones include HEAD and SHOULDERS,
TRIANGLES, RECTANGLES, DOUBLE TOPS, DOUBLE BOTTOMS and FLAGS.
Also, chart landscape features such as GAPS and TRENDLINES are
said to have great significance on the future course of price
Indicator analysis uses math
calculations to measure the relationship of current price to
past price action. Almost all
indicators can be categorized as TREND-FOLLOWING or OSCILLATORS.
Popular trend-following indicators include MOVING AVERAGES, ON
BALANCE VOLUME and MACD. Common oscillators include STOCHASTICS,
RSI and RATE OF CHANGE. Trend-following indicators react much
more slowly than oscillators. They look deeply into the rear
view mirror to locate the future. Oscillators react very quickly
to short-term changes in price, flipping back and forth between
OVERBOUGHT and OVERSOLD levels.
Both patterns and indicators measure
market psychology. The core of
investors and traders that make up the market each day tend to
act with a herd mentality as price rises and falls. This
"crowd" tends to develop known characteristics that
repeat themselves over and over again. Chart interpretation
using these two important analysis tools uncovers growing stress
within the crowd that should eventually translate into price
|The most popular technical indicator
for studying stock charts is the MOVING AVERAGE.
This versatile tool has many important uses for investors and
Take the sum of any number of previous
CLOSE prices and then divide it by that same number. This
creates an average price for that stock in that period of time.
A moving average can be displayed by recomputing this result
daily and plotting it in the same graphic pane as the price
bars. Moving averages LAG price. In other words, if price starts
to move sharply upward or downward, it will take some time for
the moving average to "catch up".
Plotting moving averages in stock
charts reveals how well current price is behaving as compared to
the past. The power of the moving
average line comes from its direct interaction with the price
bars. Current price will always be above or below any moving
average computation. When it is above, conditions are
"bullish". When below, conditions are
"bearish". Additionally, moving averages will slope
upward or downward over time. This adds another visual dimension
to a stock analysis.
Moving averages define STOCK TRENDS. They
can be computed for any period of time. Investors and traders
find them most helpful when they provide input about the
SHORT-TERM, INTERMEDIATE and LONG-TERM trends. For this reason,
using multiple moving averages that reflect these
characteristics assist important decision making. Common moving
average settings for daily stock charts are: 20 days for
short-term, 50 days for intermediate and 200 days for long-term.
One of the most common buy or sell
signals in all chart analysis is the MOVING AVERAGE CROSSOVER. These
occur when two moving averages representing different trends
criss-cross. For example, when a short-term average crosses
BELOW a long-term one, a SELL signal is generated. Conversely,
when a short-term crosses ABOVE the long-term, a BUY signal is
Moving averages can be "speeded
up" through the application of further math calculations. Common
averages are known as SIMPLE or SMA. These tend to be very slow.
By giving more weight to the current changes in price rather
than those many bars ago, a faster EXPONENTIAL or EMA moving
average can be created. Many technicians favor the EMA over the
SMA. Fortunately all common stock chart programs, online and
offline, do the difficult moving average calculations for you
and plot price perfectly.
|Support and Resistance
|The concept of SUPPORT AND RESISTANCE
is essential to understanding and interpreting stock charts. Just
as a ball bounces when it hits the floor or drops after being
thrown to the ceiling, support and resistance define natural
boundaries for rising and falling prices.
Buyers and sellers are constantly in
battle mode. Support defines that
level where buyers are strong enough to keep price from falling
further. Resistance defines that level where sellers are too
strong to allow price to rise further. Support and resistance
play different roles in uptrends and downtrends. In an uptrend,
support is where a pullback from a rally should end. In a
downtrend, resistance is where a pullback from a decline should
Support and resistance are created
because price has memory. Those
prices where significant buyers or sellers entered the market in
the past will tend to generate a similar mix of participants
when price again returns to that level.
When price pushes above resistance, it
becomes a new support level. When
price falls below support, that level becomes resistance. When a
level of support or resistance is penetrated, price tends to
thrust forward sharply as the crowd notices the BREAKOUT and
jumps in to buy or sell. When a level is penetrated but does not
attract a crowd of buyers or sellers, it often falls back below
the old support or resistance. This failure is known as a FALSE
Support and resistance come in all
varieties and strengths. They
most often manifest as horizontal price levels. But trendlines
at various angles represent support and resistance as well. The
length of time that a support or resistance level exists
determines the strength or weakness of that level. The strength
or weakness determines how much buying or selling interest will
be required to break the level. Also, the greater volume traded
at any level, the stronger that level will be.
Support and resistance exist in all
time frames and all markets.
Levels in longer time frames are stronger than those in shorter