Hello Investor –
There are many different ways to look at a stock chart, but I want to keep it simple here. This is a basic overview of some key concepts. It is not a dissertation on advanced indicators and charting strategies. The goal is to give you some tools that will allow you to quickly analyze a chart to see whether or not a trade might be worth pursuing.
Moving Averages
Moving averages are technical indicators that can help you identify “support” and “resistance” for a stock (or the market). A moving average (MA) is the average price of a stock over a specified time period of time.
Some of the most common time periods used are 20, 50, 100 and 200 days. Moving averages are used to help spot price trends and are perhaps the most commonly used chart indicator. All good stock charting software includes built-in moving average indicators, and most of the financial sites have them as well.
Time Period
Stock charting software allows you to plot charts for many time periods: yearly, monthly, weekly — even hourly and down to the minute. The time frame you choose really depends on your specific trading style and how you want to use the information.
Volume
Volume is the number of stock shares traded during a given period of time. Volume is extremely important as it helps determine a stock’s momentum. In most charts, you can use the settings to see the volume indicator. Each vertical bar represents one day’s trading volume.
The taller the volume bar, the greater the number of shares traded that day. Big volume spikes can indicate an impending breakdown or breakout on a stock.
Daily Trade Range
On a daily chart, each vertical bar represents one trading day. If you look at any bar chart online, you’ll see both red and green bars. A red bar means a stock or index traded DOWN overall on the day compared to the previous day.
A green bar means the stock or index traded EVEN or UP on the day compared to the previous day. You can also set your parameters for weekly and monthly outlooks if you are looking at a longer-term chart.
Support and Resistance
Support is a temporary floor for the stock. The more times the stock touches this area and fails to continue down through this level, the stronger this support level becomes.
Once a stock’s price starts to rise, it often climbs to the next price level that’s been reached before. This is called resistance as it can act as a temporary ceiling for the stock. The more times the stock touches this area and fails to continue up through this level, the stronger this resistance level becomes.
After you discover support and resistance levels for a stock, you can lay the foundation for most of your trades. This is very important. If support and resistance levels are broken, then their roles reverse as prior resistance can become support and prior support can now become resistance.
Range-Bound and Channel Stocks
A range-bound stock simply ping pongs back and forth between its support and resistance levels.
Trading range bound-stocks can be profitable. However, always remember that stocks can break through resistance levels and break down through support levels.
A price channel is a pair of parallel trend lines that form a pattern for a stock. Price channels can be horizontal, ascending or descending. A channel forms when a stock repeatedly bounces off support and then drops back to or near its support line after hitting resistance.
You can draw a parallel line connecting the “top of the mountains” and a line connecting the bottoms, “or valleys” to get ascending or descending trends. These trend lines define the channel.
Broken Trend
When a stock’s price passes through and stays above or below a trend line that represents support or resistance, then the trend is said to be broken, and a breakout or breakdown may occur.
Breakout / Breakdown
A breakout occurs when a stock’s price moves up through and stays above its resistance level.
A breakdown occurs when a stock’s price moves down through and stays below its support level.
Uptrends / Downtrends
If the price is sloping up and the lows are getting higher and higher, then it is likely that the stock is in an uptrend.
If the price is sloping down and the highs are getting lower and lower, then it is likely that the stock is in a downtrend.
Golden Crosses
A golden cross forms when a shorter-term moving average (MA) crosses above a longer-term moving average. This is considered a bullish sign because the shorter-term MA reflects the most recent price action relative to the longer-term MA. Obviously, the bigger the difference in moving averages the better, but the occurrence of a golden cross can be used as confirmation of a continued uptrend.
A “classic” golden cross signal is when the 50-day MA crosses above the 200-day MA. You might also hear me refer to a “mini” golden cross, which is when the 100-day MA crosses over the 200-day MA. Both indicate that higher prices could be in store, but classic gold crosses are usually more reliable.
Death Cross
A death cross forms when a shorter-term moving average (MA) falls below a longer-term moving average. This is considered a bearish indicator. A “classic” death cross signal is when the 50-day MA drops above the 200-day MA.
Putting it All Together
Charting should always be a part of your timing strategy for entry and exits points for stock and option trades. To stack the odds in your favor, you need to look at a chart to see if a stock is going (or about to go) in the direction you want.
You also want to have a clear picture of the current, broader market environment before entering a trade. For example, even if you decide to trade a stock in a strong uptrend, if the overall market is bearish, then the stock or options may not see gains.
The same is true if the market is going higher and you decide to short a stock or buy put options. A rising tide tends to lift all ships, and even stocks that are breaking down can get a boost from the market’s bullish momentum.
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