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Chart Reading Basics

Author: David J. Kosmider (info)
Website: http://eidoan.com/
Posted: January 10th, 2007 at 10:30 am EST
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One type of technical analysis is the process of “reading” stock charts. Basically, this involves looking at a chart to try to observe patterns in the price movement that could help you determine what a stock will do in the future. The concept is simple, but it takes many hours of study and observation to learn. However, one problem that still exists after you master this is that just looking at charts for your trades is a very subjective judgment and usually not backed up by scientific-style testing. But whether you use it for making trades or not, it is still a good thing for all traders to understand.

First you need to know what you are looking at. For analysis, you should either use a bar setting of OHLC or Candlesticks. These settings turn every day on the chart into a vertical bar that shows the open, high, low and closing price of that day.

Some of the most common patterns that you will see involve Trend Lines. Trend lines are simply lines that are drawn on a chart to connect several relative highs or lows. They can either be directly horizontal or diagonal upward or downward. If a stock has clear trend lines then these points can be a good indication of places to buy or sell. Lines where stocks hit bottoms and move higher off of are called Support Lines while lines that the price moves downward from are called Resistance Lines.

Other types of patterns that chart analysts will look for involve more complicated price formations. Some of these include: Triangles, Head & Shoulders, Elliott Waves, and Rounded Tops/Bottoms. Head & Shoulders (bearish version) is common pattern in which a stock will reach three relative highs, with the middle one being higher than the other two. This usually indicates the coming of a strong downward trend. With a Triangles pattern, the price of a stock is moving up and down inside clearly definable trend lines that are narrowing. When the price reaches the point of the triangle it breaks suddenly either up or down, depending on the type of triangle and the previous trend. Rounded Tops and Bottoms are instances where a stock slows down in movement just before it reverses. Usually these happen after strong upward or downward trends. Elliott waves involve a complex set of specific upward movements followed by a set of downward movements.

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