Why an Understanding of Stock Charts is Critical
As an investor on the stock market, whether as a trader who flips shares often or as a more long-term investor, chart reading and engineering insights from chart data is one of the more critical skills you’ll need to acquire. Unpacking the movements on a chart lets you see what the pack is doing, and tell you either to stick with them, get ahead of them or break away completely, depending on your strategy.
Whatever you choose to do you need to know what the baseline fluctuations are at any given point in time.
The pack in the case of stock trading will mostly comprise investors who act on behalf of large financial institutions, fund managers and group fund managers. Their mass buying and selling, or “share dumping”, is what pushes stock prices up or down. At least initially, it makes sense to avoid buying stocks they’re getting rid of, for example. But how would you know which stocks have fallen out of favour?
Once you learn how to analyse charts you’ll be able to spot these patterns or trends on your chart quickly and extract an increasing amount of detail as you become more adept at interpreting chart data. It can form the basis of your decisions to buy, sell or hold your stock positions.
Understanding the Hidden Chart Narratives
The first time you use a trading platform or charting software, deciphering what’s happening on the chart in front of you may be intimidating. However, you don’t need to be a rocket scientist to make sense of what you’re seeing. A chart is simply a visual representation of:
- Changes to a share price
- Changes in the numbers or volume of particular shares being traded
- A recording of when these changes are happening
Some of the fact-based patterns you’ll be able to see emerging with a stock are:
- Are fund managers buying or offloading a particular share or class of shares?
- Are downward price movements deceptive? Have big investors actually been buying the stock despite the share price tumbling? If so, could this mean price gains in future?
- What has the market reaction been to news or information about a stock? Are institutional investors picking up the stock despite bad news? Do other investors know something you don’t?
This means that a storyline based on fact and statistics lies beneath the dots, vertical bars and horizontal lines. Unlike market sentiment or speculation, what you’ll be looking at won’t be an urban myth but rather an accurate analysis. It is then up to you to decide whether you agree with what’s transpired or not. To a certain extent, it can also help predict whether a stock will continue to rise or fall.
Weekly, Daily or Intraday Charts: Which do Seasoned Professionals Prefer?
Is timing everything in stocks, as it is with most other things in life? In other words, when getting to grips with how to analyse charts, is it better to look at daily or weekly charts? Most seasoned professionals agree that there are benefits to looking at both.
When you’re a novice what matters most is that the charts are not so cluttered with detail so as to make them unhelpful. Also closely study a stock chart guide, particularly if you’re just starting out.
There is little consensus on whether day or full-week charts are best, so we’ll point out the benefits of each in the next section. Once you find your rhythm it’s about deciding what works best for your strategy, which may even involve reading both charts.
On the other hand, most experts agree that intraday charts are best avoided unless you have the nerves and experience to be able to detach from the level of highly short-term detail you are likely to encounter. This is because the trajectory of a stock may change wildly in a few hours, so without experience, it’s unwise to take a position on a stock based on the data an intraday chart is yielding.
Weekly vs Daily Charts: The Benefits of Each
So, what are the advantages of looking at a weekly stock chart? Here are some:
- It gives a wider perspective than a day chart because the graph movement of a stock is tracked over a longer timeframe. It’s often easier not to be unnerved by a weekly chart.
- It helps you get around the challenge of being bogged down by smaller, more insignificant fluctuations. On a daily chart these same fluctuations could look massive and you could infer an obscured picture.
- Most bullish patterns – a bull run being when a share is on the rise for a period of time, broadly speaking – is easier to see on a weekly chart.
- You can spot a bearish railroad-tracks pattern only on a weekly chart. We will discuss this in the next section.
There are also distinct benefits to looking at daily charts including; counting the days to see if a share sets in motion the eight-week hold rule is more accurate on the daily chart; investors claim that you can spot a climbing base easier on a daily chart; If you’re looking to follow through with a stock the next day because a new upward trend has begun, you’ll see it more easily on a daily chart.
Bearish Railroad-Tracks and the Eight-Week Hold Rule Explained
Having just identified that some patterns are easier to spot on either the daily or weekly charts, what do these patterns mean?
Railroad tracks are one of the first patterns you’re likely to be warned about when learning how to analyse charts. Most investors agree that it’s bad news for any stock, and indicates that you should sell. The tracks consist of two vertical lines with horizontal hash marks. These horizontal marks show that the weekly closes are not far from each other. Usually they show up when a share price has hit its upward climb climax, indicating that there has been trade but no price movement. They’re called “bearish”, denoting that downward movement is usually to follow.
The eight-week hold rule. Usually if your stock has increased by 20-25%, then unless you’re a long-term investor, you want to sell and take your profits in the knowledge that greedy investors who have waited for even bigger profits after this have often been burned. However, if your stock has a proper base – in other words, the market fundamentals of your stock are correct – and it jumps 20% out of this solid base, it may just be a market-leading stock and you should not sell. Remember that these are often high-quality stocks that will inevitably be sold off hard by virtue of having triggered the eight-week rule because many investors will be tempted to take immediate profits. Sit it out.
A Bearish Wedging Handle Explained
A bearish wedging handle is also called a rising or upward wedging handle because it is usually an indicator that you should sell. It is considered to be an indication of problematic behaviour within a base. To picture a base, think of it as a cup. It is not horizontal but curved, like a saucer. The handle would be on the right-hand side, sort of like a vertical line protruding upwards. It’s as if you can pick up the cup with this (base) handle.
If the handle starts higher up the right-hand side curve, it will resemble a cup handle rather than a base handle. The cup’s left-hand side base forms when big investors sell large volumes of shares in a stock. The cup’s right-hand side base, the upward curve, forms when those big investors return to pick up large amounts of stock. The price moves higher.
Now the handle starts to protrude as supply is constrained, but more investors climb on board to try and squeeze out a profit. Ideally, what should follow is that the stock price should go gently lower in quiet trade as a handful of unsure investors sell. But institutions step in and buy into this low so a fresh high breaks out. The pattern repeats itself but the problem is, not every breakout will be successful. At some point, the high will not reach what it was before and you should have sold when it was low.
Types of Trading Charts
There are three main kinds of trading charts you are likely to encounter:
- Line charts. This is the simplest one and a sensible starting point when you begin. It shows you only a closing price over a period of time, with few or no other “distractions”. This is because the closing price is often thought to be key to analysing stock performance. The line chart is formed by connecting the closing prices over a defined time frame. There is no trading range, meaning that, for one thing, you won’t see opening prices. You also won’t see trading highs or lows – only closing prices and the patterns they are forming.
- Bar charts. These give you more detail. What you’ll see is a sequence of vertical lines with each vertical line representing trading information. Included are the highs and lows of the trading period covered in the chart. You’ll also see the opening and closing prices – these are represented by shorter lines.
- Candlestick chart. This is the one with the most comprehensive detail, so when learning how to analyse charts, it is the one you should leave for last. However, because of the kind of insights you can glean, it is the one probably most likely to inform your trading strategies. It is most similar to the bar chart so once you have mastered the bar chart, this is more than half the stock trading chart reading challenge done.
Chart Analysis is Essential to Trade Even if Patterns are not an Exact Science
Of course, the whole point of reading charts and analysing them is spotting trends. Trends form the basis of most predictions that you’ll make and therefore inform your buying, holding or selling positions. The trends or patterns you see or “draw” though will be subjective – you may see a base while another trader sees a fully-formed cup based on what he or she knows about the stock. This means that drawing chart patterns are not an exact science – in addition to the next trader drawing a different pattern, they may even draw a different breakout point.
Naturally, these differences affect the performance of trades based on the patterns. If you’re a new trader in particular you should not lose heart or faith in your own ability if you are not able to make a profit based on trading charts. While it is almost certain that you eventually will spot patterns and be able to make money off of what you see, what is an absolute given is that you will never make money if you can’t draw trends or patterns in the first place. With practice, patience and experience, you’ll not only draw patterns well but know which ones are telling you to buy, hold or sell.
