Most worthwhile goals require a bit of perseverance. After all, you wouldn’t want visit a dentist who had just decided to work on teeth that morning! And many pursuits demand some preparation and tenacity to build a knowledge base. That’s definitely true when you decide to learn about stock-market investing. A key step in that process is learning to read stock charts, a process also known as technical analysis.
Anyone can learn technical analysis. All you need is a stock charting program. There are many free options available on the Internet, such as Free Stock Charts by Worden Brothers. There are also many services you can pay for. Some of the paid services contain additional information, such as a complete database of company fundamentals, but you can absolutely master chart-reading basics with a free program.
Here’s how to do just that in 5 easy steps.
Step 1. Understand Price And Volume Bars
Price and volume are the basic building blocks of stock charts. You can find these represented in various forms on chart programs. Two of the most common forms you’ll find are a) high, low, close and b) candlestick. Unless you really understand the price and volume bars, the rest of the chart will become more confusing.
Fortunately, the price and volume areas of a stock chart are pretty simple to comprehend. Generally, one color signifies a day or week in which a stock closed higher; a different color signifies a day or week when it closed lower. Volume bars are higher during times of heavy trading, and lower when fewer shares moved. Generally speaking, you prefer to see higher volume when a stock makes price gains, and lower volume when it declines. If a stock falls on very heavy trading, it means a lot of investors were bailing out.
Step 2. Identify Moving Average Lines
These are also key to getting a handle on a stock’s price movement. Moving average lines show the average of a stock’s closing prices over a specified period of time. You can also check the moving average for an index, such as the Dow or the S&P 500.
Moving average lines are useful in showing you whether a stock is getting support from professional investors, including hedge funds and mutual funds. If a stock falls below a key moving average, such as its 50-day line, then it often means professional investors are selling heavily. Professional investors determine the direction of the market, so if you spot sighs of their selling, it may be time for you to also head for the exit.
Step 3. Identify Basic Stock Chart Patterns
Stocks tend to form some of the same patterns, over and over again. The cup with handle and double bottom are two chart patterns that stocks often form before making big price run-ups. If you learn to see these patterns on a chart, you could potentially identify big winners before they zoom higher in price. That’s how many successful growth investors have made money in the market.
Here’s an example of a cup and handle pattern that Salesforce.com formed in the early months of 2010.
Step 4. Understand Trend Lines
Stocks often form distinctive trends as they move up or down in price. One excellent way to identify a trend is by drawing a line between three points on a stock chart. If you can spot a trend line, you can also see if a stock is breaking it. That’s frequently a signal of trouble ahead. The most successful stock market investors have learned to identify these signals early, allowing them to protect their gains.
Step 5. Learn To Use The Relative Strength Line
This is a very useful element of many charting programs. It shows you a stock’s price performance relative to the general market, usually with the S&P 500 benchmark index as a proxy. The relative strength line is a fast way to visually determine how well a stock’s price action is performing, versus the broader market. If the line is heading lower, use caution! It means your stock is seriously underperforming, and that’s not the type of investment you want in your portfolio.
If you follow this advice, you’ll be on your way to successful stock chart reading. It’s really not as difficult as many so-called experts claim, and with a little practice, it will help your investing immeasurably.
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