How to read stock charts

What is a stock chart? 

A stock chart visually represents a stock's price movement over time. Also known as a 'price chart', it typically displays the stock's opening, closing, high, and low prices for each day, week, or month and the volume of shares traded. 

Investors and analysts use stock charts to review trends and patterns in stock price movements, which can help inform their investment decisions.

Stock charts can also display technical indicators, such as moving averages, the relative strength index (RSI), and the moving average convergence divergence (MACD), which can help investors and traders identify trends and potential trading opportunities.

How do you read one? 

Reading a stock chart can be overwhelming at first, but it becomes easier with practice. 

Here are some steps to help you read a stock chart:

1. Determine the time frame: The first step in reading a stock chart is determining the time frame you want to analyse. Most stock charts allow you to view daily, weekly, or monthly price movements.
2. Identify the chart type: There are several types of stock charts, including line charts, bar charts, and candlestick charts. Identify the type of chart you are looking at.
3. Look at the x-axis: The x-axis of a stock chart represents time. It shows the dates or time period for the price movements displayed.
4. Look at the y-axis: The y-axis represents the stock's price movements. It displays the stock's price on the vertical axis, usually with the higher prices at the top and lower prices at the bottom.
5. Identify trends: Look for patterns in the chart, such as upward or downward trends, and note any significant price movements or changes in trading volume. Technical indicators can also help identify trends.
6. Identify support and resistance levels: Support levels are price levels where buying pressure has historically been strong enough to prevent the stock from declining further. Resistance levels are price levels where selling pressure has historically been strong enough to prevent the stock from rising further.
7. Analyse the chart: After identifying trends, support and resistance levels, and other chart patterns, analyse the information to make informed investment decisions.

It's important to remember that stock charts are just one tool for analysing a stock's performance, which investors should use in conjunction with other research and analysis methods to make informed investment decisions.

What type of chart should you use? 

There are several types of stock charts, including line charts, bar charts, and candlestick charts. Line charts display the stock's price movement as a line that connects the closing prices over time. 

Bar charts display the opening and closing prices and the high and low prices for each day as vertical bars. Candlestick charts show the same information as bar charts but use candlestick shapes to represent the opening and closing prices and the high and low prices for each day.

The type of stock chart you should use depends on what information you are trying to find and what analysis you want to perform. Different chart types display price movements differently. 

Line charts indicate the general trend of a stock's price movement, while bar charts and candlestick charts show more detail. 

For shorter time frames, such as intraday or daily, candlestick charts or bar charts may be more appropriate. Line charts may be more appropriate for longer time frames, such as weekly or monthly.

Ultimately, the best type of stock chart depends on your needs and preferences. It's a good idea to experiment with different chart types and find the one that works best for you.

How to analyse a stock chart as a beginner 

For a beginner analysing a stock chart, the first step is ensuring you understand the chart and what it represents. Look for patterns in the graph that indicate a trend, such as an upward or downward slope. 

Try to identify the long-term trend of the stock. Look for support and resistance levels. Check the volume of shares traded to see if it supports the movement you've identified. For example, if the stock rises and the volume increases, it may indicate a strong bullish trend. 

Technical indicators can provide additional information about a stock's performance, and chart patterns can provide clues about future price movements. Some common patterns include head and shoulders, double tops and bottoms, and triangles. Look for these patterns on the chart and use them to inform your analysis.

Why is volume important? 

Volume is an essential component of stock charts because it represents the number of shares traded during a given period. 

Volume can confirm a trend seen in price movements. Higher volume during an upward trend can signal increased buying interest, while higher volume during a downward trend can signal increased selling pressure.

Volume can help identify potential trend reversals. A sharp increase or decrease in volume can indicate a change in market sentiment and may be a warning sign of a possible trend reversal. 

Volume can also provide clues about the momentum of a stock. An increase in volume during an upward trend can indicate a strengthening of the movement, while decreasing volume during an upward trend can signal a weakening trend.

Volume can also influence price movements. For example, a large increase in volume may cause a stock's price to spike or drop significantly. 

Volume is an important tool for investors to use when analysing stock charts. It provides additional information about a stock's performance and can help investors make more informed investment decisions.

What are the main stock chart patterns and what do they mean? 

There are several common stock chart patterns. Here is what they typically mean.

Head and shoulders

The head and shoulders pattern is bearish and signals a potential trend reversal. It consists of three points, with the middle being the highest (the 'head') and the other two being lower (the 'shoulders').

The pattern is complete when the price breaks below the neckline, which connects the lower points between the shoulders.

Double top/double bottom

The double top is a bearish pattern that signals a potential trend reversal, while the double bottom is a bullish pattern that also signals a possible trend reversal. The double top consists of two peaks that are roughly equal in height, while the double bottom consists of two troughs that are roughly equal in depth.

The pattern is complete when the price breaks below the support level (in the case of the double top) or above the resistance level (in the case of the double bottom).

Triangle

The triangle pattern can be either a bullish or bearish pattern, depending on whether it's a symmetrical triangle or an ascending/descending triangle.

A symmetrical triangle is formed when the price creates a series of lower highs and higher lows. We see an ascending triangle when the price makes a series of higher lows and a flat resistance level. A descending triangle is formed when the price creates a series of lower highs and a flat support level.

The pattern is complete when the price breaks above the resistance level (in the case of an ascending triangle) or below the support level (in the case of a descending triangle).

Cup and handle

The cup and handle pattern is a bullish pattern that signals a potential trend continuation. It comprises a U-shaped cup and a short consolidation period (the handle). The pattern is complete when the price breaks above the resistance level created by the handle.

Wedge

The wedge pattern can be either bullish or bearish, depending on whether it's a rising wedge or a falling wedge. A rising wedge is formed when the price creates a series of higher highs and higher lows, while a falling wedge is formed when the price creates a series of lower highs and lower lows.

The pattern is complete when the price breaks below the support level (in the case of a rising wedge) or above the resistance level (in the case of a falling wedge).

These are just a few of the many chart patterns that investors use to identify potential price movements. It's important to remember that no pattern is foolproof, and investors should use other research and analysis methods to make informed investment decisions.

Which chart pattern is best for trading? 

There is no one 'best' stock chart pattern for trading, as different patterns can be effective in different market conditions and for different trading styles. Some traders prefer to trade short-term patterns like flags and pennants, while others focus on longer-term patterns like head and shoulders or double bottoms.

Ultimately, the effectiveness of any stock chart pattern for trading will depend on several factors, including the trader's experience and skill level, risk tolerance, and overall trading strategy. It's important for investors to have a solid understanding of technical analysis and to conduct thorough research and analysis before making any trades based on chart patterns.

In addition, it's important to remember there is always risk involved in trading stocks. Traders should always use proper management techniques to minimise risk exposure, including setting stop-loss orders and limiting position sizes.

Are there drawbacks to using stock charts? 

While stock charts can be a valuable tool for technical analysis and trading decisions, there are also some potential drawbacks. They include: 

1. Historical data may not predict future performance: Just because a stock has followed a particular trend does not mean it will continue to do so. Stock charts are based on historical data, and there is always the risk that past performance may not indicate future results.
2. Over-reliance on charts: Some investors may become too focused on stock charts and fail to consider other essential factors affecting a stock's performance, such as market news, economic indicators, and company financials.
3. False signals: Chart patterns can sometimes be deceptive and give false signals, leading people to make poor trading decisions.
4. Difficulty interpreting complex patterns: Some stock chart patterns can be complicated and tricky to interpret, especially for novice investors.
5. Technical issues: Technical glitches and delays can occur when using online charting software or trading platforms, leading to missed opportunities or incorrect trading decisions.

It's important for investors to use stock charts in combination with other research and analysis methods, such as fundamental analysis and news events, to make informed trading decisions. 

They should also be aware of the potential drawbacks and limitations of using stock charts and exercise caution when making trading decisions based on technical analysis.