The efficacy of reading stock charts has always been hotly debated but largely boils down to the question of how much information can be garnered from reading a record of a stock’s trading price, volume and time.
Those are, after all, the only data points captured on a stock chart or being used to generate technical studies.
But those studies, sometimes derisively referred to as “crayon drawings” by the fundamental investing crowd, can provide valuable insight into how a stock has traded in the past, how it’s trading now in the present, and how it may trade in the future.
For instance, an aberrantly large trade may signal that a large institutional investor (the type of investor that moves markets) is accumulating shares. And share accumulation by a large hedge fund, for example, is typically accomplished over days, not hours.
That type of market action can significantly move share prices over the course of a week or two, without any meaningful change to any fundamental criteria other than share price.
But, given the bevy of trading information and second-order studies, where does one begin?
I use several different time frames to understand a stock:
- Daily: A daily chart gives you a granular look at current support and resistance. Each bar on this chart represents a single day’s activity and can help you understand what’s happening in the short term. For example, you can easily see if a stock is getting support at a key moving average, and you can see if it’s near a buy point.
- Weekly: A weekly chart lets you easily spot long- and medium-term trends and identify chart patterns. You can also compare a stock’s performance relative to its index or the broader market.
- Monthly: I use monthly charts to understand a stock’s longer-term history, perhaps going back to its IPO, or even to get a sense of strength over the past year. This won’t help you identify patterns as well, but it can give you an excellent perspective.
- Intraday: Intraday time frames give you a sense of whether the big institutions’ trading desks are buying or selling throughout the session. It can also easily show you whether gaps are closing and if a stock is reversing course during the trading day. You can use varying intraday time frames, such as one minute, five minutes, 10 minutes, 30 minutes, or an hour.
So why bother learning how to understand stock charts? Why not just check the earnings and sales and simply use the fundamentals as your indicators?
The short answer is: Use both.
The combination of fundamentals and chart reading can clue you into stocks with the potential to stage a fresh rally.
Learning how to understand stock charts - or “technical analysis” - gives you a shortcut to uncovering opportunities or risks. It’s one more tool in the box to help you.
Technical analysis can help you size up the potential opportunities and risks of buying or selling a stock without flying blind.
We’re lucky today that we have many excellent charting programs. That wasn’t always true.
One often-told story centered around Investor’s Business Daily founder Bill O’Neil, who, when working as a stockbroker in the 1960s and 1970s, would spend hours marking up charts on paper.
If you read the classic trading book Reminiscences of a Stock Operator you may recall Jesse Livermore studying the old ticker tape in the bucket shops, where people essentially gambled on the stock market. He didn’t have the benefit of charts.
Nicolas Darvas was another pre-computer-age investor who relied on his own systems. As a professional dancer, Darvas traveled the world to put on shows. While on the road, he would rely on stock-market tables from the Wall Street Journal to create his own charts. Sometimes, when he was overseas, the Journal would be delivered weeks later and Darvas was forced to use outdated information.
Still, he was able to use his homemade charts to determine the best times to buy and sell, and his story is detailed in the classic investment book, How I Made $2,000,000 in the Stock Market.
Those lessons from many decades ago still apply. The stock market is certainly one area of life where history repeats, at least when it comes to prices rising and falling. The same patterns, it turns out, present themselves over and over again. Whether it’s railroad stocks a century ago or the FAANG and biotech tech stocks of today, you’ll see the same buy and sell signals.
Some investors claim that today’s algorithms and artificial intelligence have made learning how to understand stock charts obsolete, as the machines have taken the place of human judgment and emotion. However, institutions are staffed by real people, who gauge the market in conjunction with the technology available today.
Market sentiment still plays a role, so don’t throw in the towel assuming the machines are in charge. Even with algorithms, the big institutions still make trading decisions every minute of every day, and chart reading allows you to look over their shoulders and profit from the clues they leave behind.