charts gained popularity in the late 19th Century from
the writings of Charles H. Dow in the Wall Street Journal.
His comments, later known as "Dow Theory",
alleged that markets move in all kinds of measurable
trends and that these trends could be deciphered and
predicted in the price movement seen on all charts.
ANALYSIS seeks to determine future stock price by
understanding and measuring the objective "value"
of an equity. The study of stock charts, known as TECHNICAL
ANALYSIS, believes that the past action of the market
itself will determine the future course of prices.
chart is a simple two-axis (x-y) plotted graph of price
and time. Each individual equity, market and index
listed on a public exchange has a chart that illustrates
this movement of price over time. Individual data plots
for charts can be made using the CLOSING price for each
day. The plots are connected together in a single line,
creating the graph. Also, a combination of the OPENING,
CLOSING, HIGH and/or LOW prices for that market session
can be used for the data plots. This second type of
data is called a PRICE BAR. Individual price bars are
then overlaid onto the graph, creating a dense visual
display of stock movement.
charts can be created in many different time frames.
Mutual fund holders use monthly charts in which
each individual data plot consists of a single month
of activity. Day traders use 1 minute and 5 minute stock
charts to make quick buy and sell decisions. The most
common type of stock chart is the daily plot, showing
a single complete market session for each unit.
charts can be drawn in two different ways. An ARITHMETIC
chart has equal vertical distances between each unit
of price. A LOGARITHMIC chart is a percentage growth
chart. It has equal vertical distances between the same
percentages of price growth. For example, a price movement
from 10 to 20 is a 100% move. A move from 20 to 40 is
also a 100% move. For this reason, the vertical distance
from 10 to 20 and the vertical distance from 20 to 40
will be identical on a logarithmic chart.
chart analysis can be applied equally to individual
stocks and major indices. Analysts use their technical
research on index charts to decide whether the current
market is a BULL MARKET or a BEAR MARKET. On individual
charts, investors and traders can learn the same thing
about their favorite companies.
stock chart to identify the current trend. A trend
reflects the average rate of change in a stock's price
over time. Trends exist in all time frames and all markets.
Day traders can establish the trend of their stocks
to within minutes. Long term investors watch trends
that persist for many years.
can be classified in three ways: UP, DOWN or RANGEBOUND.
uptrend, a stock rallies often with intermediate
periods of consolidation or movement against the trend.
In doing so, it draws a series of higher highs and higher
lows on the stock chart. In an uptrend, there will be
a POSITIVE rate of price change over time.
downtrend, a stock declines often with intermediate
periods of consolidation or movement against the trend.
In doing so, it draws a series of lower highs and lower
lows on the stock chart. In a downtrend, there will
be a NEGATIVE rate of price change over time.
price swings back and forth for long periods between
easily seen upper and lower limits. There is no apparent
direction to the price movement on the stock chart and
there will be LITTLE or NO rate of price change.
tend to persist over time. A stock in an uptrend
will continue to rise until some change in value or
conditions occurs. Declining stocks will continue to
fall until some change in value or conditions occurs.
Chart readers try to locate TOPS and BOTTOMS, which
are those points where a rally or a decline ends. Taking
a position near a top or a bottom can be very profitable.
can be measured using TRENDLINES. Very often a straight
line can be drawn UNDER three or more pullbacks from
rallies or OVER pullbacks from declines. When price
bars then return to that trendline, they tend to find
SUPPORT or RESISTANCE and bounce off the line in the
quote about trends advises that "The trend is your
friend". For traders and investors, this wisdom
teaches that you will have more success taking stock
positions in the direction of the prevailing trend than
measures the participation of the crowd. Stock charts
display volume through individual HISTOGRAMS below the
price pane. Often these will show green bars for up
days and red bars for down days. Investors and traders
can measure buying and selling interest by watching
how many up or down days in a row occur and how their
volume compares with days in which price moves in the
that are bought with greater interest than sold are
said to be under ACCUMULATION. Stocks that are sold
with great interest than bought are said to be under
DISTRIBUTION. Accumulation and distribution often LEAD
price movement. In other words, stocks under accumulation
often will rise some time after the buying begins. Alternatively,
stocks under distribution will often fall some time
after selling begins.
volume for a stock to rise but it can fall of its own
weight. Rallies require the enthusiastic participation
of the crowd. When a rally runs out of new participants,
a stock can easily fall. Investors and traders use indicators
such as ON BALANCE VOLUME to see whether participation
is lagging (behind) or leading (ahead) the price action.
trade daily with an average volume that determines their
LIQUIDITY. Liquid stocks are very easy for traders
to buy and sell. Illiquid stocks require very high SPREADS
(transaction costs) to buy or sell and often cannot
be eliminated quickly from a portfolio. Stock chart
analysis does not work well on illiquid stocks.
accompanied by volume much higher than the average for
that stock are healthy for the continuation of
the price movement in that direction. But after long
rallies or declines, stocks often have a day of very
high volume known as a CLIMAX. During these days, the
last of the buyers or sellers take positions. The stock
then reverses as there are no longer enough participants
to cause price to move in that direction.
you organize the endless stream of stock chart data
into a logical format that doesn't require rocket
science to interpret? Charts allow investors and traders
to look at past and present price action in order to
make reasonable predictions and wise choices. It is
a highly visual medium. This one fact separates it from
the colder world of value-based analysis.
chart activates both left-brain and right-brain functions
of logic and creativity. So it's no surprise that
over the last century two forms of analysis have developed
that focus along these lines of critical examination.
form of interpreting charts is PATTERN ANALYSIS. This
method gained popularity through both the writings of
Charles Dow and Technical Analysis of Stock Trends,
a classic book written on the subject just after World
War II. The newer form of interpretation is INDICATOR
ANALYSIS, a math-oriented examination in which the basic
elements of price and volume are run through a series
of calculations in order to predict where price will
analysis gains its power from the tendency of charts
to repeat the same bar formations over and over again.
These patterns have been categorized over the years
as having a bullish or bearish bias. Some well-known
ones include HEAD and SHOULDERS, TRIANGLES, RECTANGLES,
DOUBLE TOPS, DOUBLE BOTTOMS and FLAGS. Also, chart landscape
features such as GAPS and TRENDLINES are said to have
great significance on the future course of price action.
analysis uses math calculations to measure the relationship
of current price to past price action. Almost all
indicators can be categorized as TREND-FOLLOWING or
OSCILLATORS. Popular trend-following indicators include
MOVING AVERAGES, ON BALANCE VOLUME and MACD. Common
oscillators include STOCHASTICS, RSI and RATE OF CHANGE.
Trend-following indicators react much more slowly than
oscillators. They look deeply into the rear view mirror
to locate the future. Oscillators react very quickly
to short-term changes in price, flipping back and forth
between OVERBOUGHT and OVERSOLD levels.
patterns and indicators measure market psychology. The
core of investors and traders that make up the market
each day tend to act with a herd mentality as price
rises and falls. This "crowd" tends to develop
known characteristics that repeat themselves over and
over again. Chart interpretation using these two important
analysis tools uncovers growing stress within the crowd
that should eventually translate into price change.
popular technical indicator for studying stock charts
is the MOVING AVERAGE. This versatile tool has many
important uses for investors and traders.
the sum of any number of previous CLOSE prices and then
divide it by that same number. This creates an average
price for that stock in that period of time. A moving
average can be displayed by recomputing this result
daily and plotting it in the same graphic pane as the
price bars. Moving averages LAG price. In other words,
if price starts to move sharply upward or downward,
it will take some time for the moving average to "catch
moving averages in stock charts reveals how well current
price is behaving as compared to the past. The power
of the moving average line comes from its direct interaction
with the price bars. Current price will always be above
or below any moving average computation. When it is
above, conditions are "bullish". When below,
conditions are "bearish". Additionally, moving
averages will slope upward or downward over time. This
adds another visual dimension to a stock analysis.
averages define STOCK TRENDS. They can be computed
for any period of time. Investors and traders find them
most helpful when they provide input about the SHORT-TERM,
INTERMEDIATE and LONG-TERM trends. For this reason,
using multiple moving averages that reflect these characteristics
assist important decision making. Common moving average
settings for daily stock charts are: 20 days for short-term,
50 days for intermediate and 200 days for long-term.
the most common buy or sell signals in all chart analysis
is the MOVING AVERAGE CROSSOVER. These occur when
two moving averages representing different trends criss-cross.
For example, when a short-term average crosses BELOW
a long-term one, a SELL signal is generated. Conversely,
when a short-term crosses ABOVE the long-term, a BUY
signal is generated.
averages can be "speeded up" through the application
of further math calculations. Common averages are
known as SIMPLE or SMA. These tend to be very slow.
By giving more weight to the current changes in price
rather than those many bars ago, a faster EXPONENTIAL
or EMA moving average can be created. Many technicians
favor the EMA over the SMA. Fortunately all common stock
chart programs, online and offline, do the difficult
moving average calculations for you and plot price perfectly.
concept of SUPPORT AND RESISTANCE is essential to understanding
and interpreting stock charts. Just as a ball bounces
when it hits the floor or drops after being thrown to
the ceiling, support and resistance define natural boundaries
for rising and falling prices.
and sellers are constantly in battle mode. Support
defines that level where buyers are strong enough to
keep price from falling further. Resistance defines
that level where sellers are too strong to allow price
to rise further. Support and resistance play different
roles in uptrends and downtrends. In an uptrend, support
is where a pullback from a rally should end. In a downtrend,
resistance is where a pullback from a decline should
and resistance are created because price has memory.
Those prices where significant buyers or sellers
entered the market in the past will tend to generate
a similar mix of participants when price again returns
to that level.
price pushes above resistance, it becomes a new support
level. When price falls below support, that level
becomes resistance. When a level of support or resistance
is penetrated, price tends to thrust forward sharply
as the crowd notices the BREAKOUT and jumps in to buy
or sell. When a level is penetrated but does not attract
a crowd of buyers or sellers, it often falls back below
the old support or resistance. This failure is known
as a FALSE BREAKOUT.
and resistance come in all varieties and strengths.
They most often manifest as horizontal price levels.
But trendlines at various angles represent support and
resistance as well. The length of time that a support
or resistance level exists determines the strength or
weakness of that level. The strength or weakness determines
how much buying or selling interest will be required
to break the level. Also, the greater volume traded
at any level, the stronger that level will be.
and resistance exist in all time frames and all
markets. Levels in longer time frames are stronger than
those in shorter time frames.