2019 UPDATE: It took six years and a great developer, but you can now learn how to read stock charts with my 156 page interactive guide, The Interactive Guide to Technical Analysis.
Learning how to read stock charts is crucial for stock traders that want to perform technical analysis. By understanding price patterns, traders have an edge at predicting where the stock is going next.
Stock Chart Types
What types of charts are available? For studying the markets by reading stock charts, here are the four main chart types used:
1. Bar charts (HLC / OHLC) – This is the most widely used chart and the default used throughout the site here on StockTrader.com. It is constructed to show four pieces of information: opening price (optional), closing price, high of the day, and low of the day. Looking at each day’s history, a vertical line shows the day’s trading range with a horizontal line pointing left to mark the opening price and a horizontal line pointing right to mark the closing price.
2. Candlestick charts – This chart presents the same data as a bar chart, but in a slightly different format. The chart has two main parts. The first is the thin line, known as the “shadow,” which shows the price range from high to low. The wider area, known as the “real body,” measures the difference between the opening price and the closing price. If the close is higher than the open, the real body is white.
3. Line charts – A line chart measures only the closing price and connects each day’s close into a line. Many technicians believe closing price is the only point that matters. For them, a line chart may be the most appropriate study.
4. Point and figure charts – A point and figure chart is concerned only with price, not time or volume. The chart uses an “X” to mark increases in price and an “O” to mark lower prices. With this approach, it is easier to spot trends and reversals. However, since time is not used as an input, P&F charts offer little guidance on timing, e.g. how long it will take for profit objectives to be met.
Each chart type for performing technical analysis has its benefits. By exploring the options each approach provides, investors can determine which type best meets their needs for reading stock charts.
Stock Chart Components
Below I have taken a stock chart of the NASDAQ Composite and labeled the main parts. Below the chart I will explain these parts and what they mean when it comes to reading a stock chart.
- Chart Identification – Every chart is labeled and tells you what exactly you are looking at. So, if we look to the left of one we can see very clearly that we are looking at a chart of $COMPQ (Nasdaq Composite) INDX. The $COMPQ is the ticker symbol of the index. Just like Google has a ticker of GOOG, and Microsoft has a ticker of MSFT.
- Summary Key – The first number displays 2303.54 which is the last price of the index. To left of this number it says “(daily)”, which means we are looking at a DAILY chart of the index. You can view charts on weekly and even monthly views. Below this we can see the blue and red lines (50 and 200) MAs. These are the price moving averages which I will explain more in point #4. Bottom line is that the summary key tells us the important numbers from the stock chart we are viewing.
- Time Period – The X axis always displays the time period. If you view the dates left to right you will find that we are viewing a chart of the months of April, May, June, and July.
- Moving Averages – Moving averages are a form of technical analysis that help identify support and resistance on a stock chart. On this chart the red line is the 200 day moving average, and the blue is the 50 day moving average.
- Volume – Volume is extremely important as it helps determine market momentum. Each bar represents one day, and the red line going through the tops is the average volume over the last xx days (in this case 60). So, the taller the volume bar, the more shares of stock that were traded that day.
- Daily Trade Range – Just like volume, each red or black vertical line on the chart represents one independent trading day. If the bar is red, that means the stock or in this case the index was DOWN overall on the day compared to the previous day. Black bars mean that the stock was even or UP on the day compared to the previous day.
Support and Resistance
Support and Resistance is a basic form of technical analysis that can be used as a way to predict stock price movement and help traders mark potential buy and sell points.
Let’s take a look at a clean support and resistance example below.
- The three “1”s show us how CVD stock found resistance at $88 three times before finally breaking through. Participating in the break would have yielded an actual return of 10% in only seven days.
- The four “2”s show distinctly how $80 was a key support level for CVD. The stock held up at this price area several times over the course of five months before it finally broke to the upside above $88 a share.
- The purple “3” shows us where the next resistance area currently is for CVD. Only time will tell if the stock will need another five month base to claim higher highs.
To help drive the concept home, here’s another example of basic support and resistance.
- A first glimpse into the resistance ENER saw around $35 a share. As we can see once the original high was made it took two more pushes to break through, which lead to a large stock price gap and new highs for the stock.
- Another example of ENER at technical resistance. This time it was at $73 a share and the third push was the one to claim higher highs.
- Here we see the support ENER has received while forming its latest base. This would also be called a support trendline. A common trend is for resistance to turn into support, which we can see with the first “3” on the left. The $60 resistance once broken then became support.
- Highlighted in purple shows us the next area the stock will most likely find resistance. Climbing above $83 a share would not represent higher highs but also new 52-week and all-time price highs.
Bases and Breakouts
As part of my own research, I love going back in time and analyzing major bases and breakouts. A base in a period of time when a stock is trading within a defined price range. Bases can take months and even years to develop. For CANSLIM investors, a six to 12 month base is a good sweet spot to look for.
A breakout occurs when the stock finally moves out of the trading range to the upside on heavy volume. Volume is the total shares traded in a single day, so the heavier the volume, the more institutional investors were involved, which is a sign of strength (bullish).
Sina Corporation’s (SINA) breakout way back in September 2010 serves as a clean example of how to read a stock chart and what to look for.
- After an exhaustion gap in late November 2009, SINA peaks over the next two months then falls into a fresh base in 2010. The base would take over 8 months to form, but its clear support and resistance set the tone for its coming breakout in September 2010.
- SINA sets up a nice handle for its base. Note how volume surged to form the left side, then dropped off again as the formation took place and prices started creeping up. Volume then returned as the stock made its key break through $46.
- Volume surges as SINA moves to fresh all time highs above $48, its next major buy point. Volume on the day was the highest of the 2010 year up to that point which is exactly what CANSLIM investors want to see: a massive accumulation day.
- After several weeks of bouncing in the low $50s, SINA retraces back under $50 and bottoms at $48.50. CANSLIM note: pull backs to the breakout area are very common and should not be feared. In this case SINA stayed $.50 above its original breakout of $48. What gets tricky is when these breakouts fall back under their breakout points. Sometimes this can cause your stop loss order to trigger prematurely.
- SINA forms a follow up base in November 2010 which sets up a secondary buy area between $62 and $63.60. SINA was already up more than 35% from its original breakout at this point.
- After a peak and pull back in early December, volume drops off as SINA forms yet another base. After such a strong run, volume dropping off minimizes any sell pressure and affirms investors are overall satisfied with the stock at its current levels. This leads into an early January breakout through $74 on record volume yet again.
For a more recent example here in 2019, take a look here at Disney’s four year base and breakout. What a beauty!
Channels and Triangles (Wedges)
Channels come in two forms: ascending and descending. Descending channels are a basic form of technical analysis spotted commonly in up trends and are considered bullish; alternatively, ascending channels are often spotted in down trends and are most often considered bearish.
When the stock breaks out of the channel, it can make for a strong entry point (buy point).
The following stock chart of Fastenal (FAST) offers a simple example of a descending channel.
- Here we see how Fastenal formed its descending channel over the course of four months. This is considered a large channel.
- The stock broke down and out of the channel on high volume. However, two days later on the volume three times greater than the average, the stock reversed back into the channel. If you would have sold the stock short (bet that the stock was going to fall in price), this would be a signal to cover and exit for a small loss. Strategy aside, this was most likely a news related price swing, and the very next week the broke out of the channel to the upside (above $40 a share).
- Slightly advanced for this post but worth noting, here we can see how the descending channel ended up acting as support at just under $38 a share (resistance becomes support). A secondary buying opportunity, the stock rallied off this support quickly ran back up above $40.
- The stock then claimed higher highs above $44 and broke out of a small base. This signifies the continuation of the uptrend that was initiated back at point “2”.
And here is an example of a symmetrical triangle (wedge) pattern followed by an ascending channel in a downtrend (bearish continuation pattern).
- Google forms the top half of its symmetrical triangle.
- Google forms the bottom half of its symmetrical triangle. The red “2” is where the pattern broke and the bears took control of the stock. This would be a great entry point for a short position (a bet that the stock is going to go down in price). As can be seen in the chart, Google dropped from $675 to under $450 (-33%) over the next two months.
- Google forms a bear flag, or what we now know as an ascending channel. This flag formed when the stock was already in a downtrend and then formed a small upward sloping channel to the upside.
- Google shares break back lower and continue their downward trend to make lower lows. The initial break is the ideal short entry point.
Stock Charts Tell Stories
Once you get the hang of reading stock charts, technical analysis allows you to observe a stock’s history in a whole new way.
For example, dry bulk shipper Dryships (DRYS) ran up over 1200% from the middle of 2007 to 2008 peaking at $131.48 on 10/29/08. The stock then fell 96% and returned to single digit levels. By applying simple technical analysis, the stock offers a wealth of knowledge valuable for investing in the future.
Commodities were red hot throughout 2006 and 2007 and analysts believed every investor should have exposure to this trend. Like all trends though, the party eventually ended and many market leaders were crushed alongside the overall market.
Referencing the weekly stock chart of Dryships below, here are five critical lessons about technical analysis and investing in trends.
- Trends are fast moving and powerful – The run from under $10 in June 2007 to $131 in October 2008 (1200%+) was no coincidence. Institutions were heavily accumulating this dry bulk carrier as commodities continued to soar. Catch a trend right and the profits can be staggering. Furthermore, never fight the trend.
- Some technical patterns are prone to failure – This “W” shaped pattern for example was considered a faulty base because the 2nd dip was not lower than the first. This is important as it allows the stock to shake out any uneasy holders before moving back up in price.
- Heavy distribution or accumulation identifies new trends – The two heavy distribution weeks in May and June 2008 were key turning points for the stock. These reversals signaled the end of DRYS’s rally.
- Tight price consolidation often signals a big move is coming – For over two months DRYS and other stocks in the same group (GNK and EXM for example) traded sideways in a fairly predictable price range. Once the stock broke down below this range though heavy selling quickly followed. Price consolidations can work in both the bulls and the bears favor.
- Know when to sell and walk away – Any investors holding onto DRYS shares thinking the stock was going to comeback were in for serious trouble. Buying even at $80 would leave the investor down 90%+ now three months later. Either use stop losses or be disciplined enough to walk away from losers before they get too big.
Taking a closer look at any stock chart and performing basic technical analysis allows you to identify chart patterns. The more you practice, the more you will see. In turn, spotting the next big winner will be an easier task.
When I started stock trading over 16 years ago, I would look at over one thousand stock charts each week. Even today, I am still learning new patterns and techniques. Practice makes perfect.
Learn to Read Stock Charts
Teach yourself stock chart patterns with my 156 page interactive course, The Interactive Guide to Technical Analysis!