If you prefer to leave math and graphs in your past with school, being a stock trader probably isn’t for you.
Stock traders fall into two categories, according to Angelo DeCandia, professor of business at Touro University: Those who care about the fundamentals of a company, such as its financials and product development, and those who care only about the movement of a stock and how it’s affected by supply and demand. If you fall into the latter category, you are a trader with less concern for the long-term prospects of a company.
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And this is “where stock charts come in, helping traders measure the movement and momentum of a stock’s up and down trading patterns,” he says.
If you want to be a successful stock trader, then you should probably know how to read stock charts.
— Introduction to stock charts.
— Basics of stock charts.
— Technical indicators and stock charts.
— Enhancing your chart reading skills.
— Final thoughts on reading stock charts.
Introduction to Stock Charts
Stock charts can appear overwhelming at first, but once you understand what they are and the story they can tell about a stock’s price movements, you may come to love them.
What Is a Stock Chart?
A stock chart is simply a graph showing the price of a stock over time. It plots time on the horizontal axis and the stock’s price on the vertical axis.
“Stock prices reflect the collective beliefs of investors about a company’s ability to make profits in the future,” says Han-Sheng Chen, an associate professor of finance at Lipscomb University’s College of Business. They’re influenced by two main factors: the company’s actual ability to generate profits and investors’ perception of that potential.
“Stock charts, which display these price movements over time, provide valuable insights into investor sentiment,” Chen says. “By understanding investor sentiment, one can improve trading strategies and increase success.”
Importance of Reading Stock Charts
Reading stock charts can give you key insights into a company’s perceived value. You can learn to recognize signals for when to buy or sell a stock and how to identify patterns to develop more effective trading strategies, Chen says. Learning to read stock charts can also help you learn how the stock market works.
But stock charts can also be overwhelming if you don’t understand their key components and what they reveal. What follows is everything you need to know about stock charts to start reading and interpreting them.
Basics of Stock Charts
Stock charts can include a wealth of information — almost too much information, some might say. The first thing to know about reading stock charts is how to find the key information you need to make a sound investment decision.
Understanding the Key Components of Stock Charts
There are several key elements most traders look for in stock charts:
— Price. A stock chart shows how a stock’s price has changed over time. You’ll likely see different prices for the open (the price the stock first traded at that morning), the high (the highest price the stock reached that day), low (the lowest price the stock reached) and the close (the last price the stock traded at before the markets closed). Some sites will show the 52-week high or low, which displays the highest and lowest prices the stock traded at over the previous 52-week period.
— Market cap. Market cap is short for market capitalization and represents the total value of the company. It’s calculated by multiplying the stock’s price by the number of shares outstanding, which is the number of shares being traded on the open market. Companies with smaller market caps tend to have more volatile trading prices, but they may also have greater long-term growth potential than large-cap stocks.
— Trading volume. This is how many shares of a stock are being traded over a given period of time. “High volume can signify strong interest in the stock, either for buying or selling,” says Adam Lampe, CEO of Mint Wealth Management in Houston, Texas. It also indicates that you’ll have an easier time finding a counterparty to your trade, making the stock more liquid.
— Time interval. The time interval over which you view the stock’s price is particularly important, Lampe says. Stock charts can be set to various time frames, from daily to weekly to several decades. “Choosing the right interval helps you match your investment horizon with market movements,” Lampe says.
These components are often correlated with investor sentiment. “If there is an amazing product or service that is expected to generate lots of interest and make lots of money, the stock price will often react positively in anticipation,” says Jim Worden, chief investment officer at The Wealth Consulting Group.
But investors can be fickle creatures. “We should always be aware that what can go up very easily can also go down very easily,” he says. “This is why investing in a diversified basket of stocks and sectors reduces the risk of massive drops in price.”
Types of Stock Charts: Line, Bar and Candlestick
Stock charts come in various forms, and each can offer a unique lens into a stock’s price movements. The three types of stock charts are the line chart, bar chart and candlestick chart.
— Line charts are your most basic stock chart. They show a stock’s closing price over time. “This chart is user-friendly and great for identifying long-term trends, such as those spanning a year,” Chen says. “It can also show shorter-term price volatility.”
— Bar charts can give more detail into a stock’s price range than line charts. Each trading day is represented as a bar on the chart with the open, high, low and closing prices. The length of the bar shows the stock’s price range for that day, with the top of the bar representing the highest price and the bottom the lowest price for the trading day. Left and right bars show the opening and closing price for the day.
— Candlestick charts “go a step further by color-coding days of gains and losses, helping investors spot patterns and market sentiment more easily,” Lampe says. The body of the candlestick will be green or red based on if the stock closed higher or lower than its opening price. The length of the entire candlestick shows the range between the high and low price for the day.
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Technical Indicators and Stock Charts
Stock charts are used by traders interested in technical analysis.
“Unlike fundamental analysis, that looks at the macroeconomic environment and company-level data — a company’s balance sheet, income statement, and statement of cash flows — technical analysis is mainly just looking at price,” Worden says. “Volume and time are also often included, but these are always looked at within the context of price.”
Basics of Technical Indicators
There are several core technical indicators traders often refer to: moving averages, trading volume, relative strength index (RSI) and moving average convergence/divergence (MACD).
Using Moving Averages
Moving averages are used to identify trends in a stock’s price over time. They do this by maintaining an average price over a fixed period of time, such as 250 days, which represents one year of trading days. It’s called “moving,” because the average is constantly recalculated. Each trading day, the oldest price is dropped from the average and the newest price is added. A rising moving average indicates an uptrend, while a falling moving average can indicate a downtrend.
“Analysts often compare shorter-term moving averages, such as a 100-day (moving average), with longer-term ones, such as a 250-day (moving average), or the current stock price,” Chen says. “When the shorter-term moving average crosses above the longer-term one, it signals a bullish sentiment shift. Conversely, when it crosses below, it indicates a bearish sentiment shift.”
Understanding Volume and Its Impact
Volume shows how much activity is occurring at a given price point. You can compare the current trading volume to the average volume over a period of time to determine if interest is rising or falling.
Let’s say a stock has an average daily volume of 1 million shares traded. “Any volume significantly above or below that average is an indication of an increased or decreased interest in the stock,” DeCandia says. “Obviously, a daily volume of 2 million shares, twice as much as the average, is an indication of stronger interest in the stock which can be a good or bad thing depending on the changing price direction, but it certainly does add conviction to whichever direction the price moves.”
Low trading volume can also impact a stock’s price and trend. “Sometimes, markets can move drastically when there is very little volume,” Worden says. “When there are fewer traders trading, this can temporarily push the market away from the current trend, either higher or lower.”
RSI and How to Use It
The RSI, or relative strength index, is a momentum indicator that measures the speed and direction of price changes. It uses an oscillator — like a ball bouncing between the floor and ceiling, DeCandia says — to show how rapidly a stock’s price changes.
Technical traders use RSI to determine if a stock is potentially overbought or oversold. An RSI below 30 generally indicates the stock is oversold and possibly undervalued, while an RSI above 70 can indicate a stock is overbought and possibly overvalued.
“While these thresholds are commonly used, some investors also analyze RSI patterns, recognizing that the values of 30 and 70 are arbitrary,” Chen says.
Interpreting MACD
The MACD, or moving average convergence/divergence, helps traders identify the direction of a stock’s price momentum, trend reversals and potential buy or sell signals. It does this by subtracting a longer-term moving average, often 26-day moving average, from a shorter-term moving average, often the 12-day moving average. The resulting line “essentially measures the gap between a quicker-reacting short-term trend and a slower-reacting long-term trend,” Lampe says. A signal line using the nine-day moving average is then used to smooth out the rapid fluctuations that can occur in the MACD line.
“When the fast-moving average crosses above the slow-moving average — that is, the MACD line crosses above the signal line, it suggests that the stock’s price might be gaining upward momentum,” Lampe says. “On the other hand, when the fast-moving average crosses below the slow-moving average, it might signal that the stock’s price is losing strength.”
He adds that it’s important not to view MACD signals in a vacuum. “They should be viewed in conjunction with core factors like market conditions, fundamentals, risk tolerance, diversification and personal investment goals in order to make well-rounded investment and portfolio management decisions.”
Enhancing Your Chart Reading Skills
Reading stock charts can be as much art as science because it’s as much about human nature as it is math.
“Technical analysis isn’t just about crunching numbers — it’s a window into the human side of the stock market,” Chen says. “It’s like diving into the realm of behavioral finance, where every chart and indicator reflects what investors think and feel.”
When you read stock charts, you’re really “delving into the psychology driving the market,” he says. As such, it’s important to keep certain do’s and don’ts of reading stock charts in mind.
Do’s and Don’ts of Reading Stock Charts
Here are the core do’s and don’ts of reading stock charts, according to experts:
— Do look for long-term trends rather than focusing on short-term fluctuations.
— Do use multiple indicators to verify a signal or trend.
— Do combine technical indicators with fundamental analysis for the strongest analysis.
— Don’t rely solely on stock charts when making an investment decision.
— Don’t use a strategy without understanding the methodology behind it.
— Don’t try to manipulate the analysis to confirm your view or desired outcome.
— Don’t let your emotions color your interpretation of the technical signals.
“The best advice I can give those who want to learn is to read and study how to use the different tools and to practice, but without using real money in the beginning,” Worden says. Technical indicators don’t always work, and often they take time to work.
“Investors should also be careful not to get too carried away with patterns and correlations,” he adds. “If investors look too much, they may see patterns where there are no clear patterns.”
Final Thoughts on Reading Stock Charts
Reading stock charts is an invaluable skill for any trader. A chart can reveal trends in a stock’s price and if it’s the right time to buy or sell. But technical analysis also has its shortcomings.
“Unlike fundamental analysis, technical analysis lacks clear-cut rules, and its effectiveness under all market conditions isn’t scientifically proven,” Chen says. “While chart reading provides insights into the past, successful stock investing hinges on predicting future trends.”
For this reason, relying solely on technical indicators when making investment decisions isn’t always wise. Instead, think of stock charts as one leg of the stool upon which to place your conviction. The more additional legs — like fundamental analysis — you combine it with, the stronger your conviction will be.
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How to Read Stock Charts originally appeared on usnews.com
Update 02/16/24: This story was previously published at an earlier date and has been updated with new information.
