Almost anyone that trades financial instruments of any kind will reference some type of chart to give them an unemotional snapshot of where a stock or market has been and where it is potentially headed. This type of investment research is most commonly referred to as technical analysis because you are strictly looking at a chart rather than a company’s financial statements to make your investing decisions.
Understanding how to read technical charts will help to give you a prospective on where a stock’s support and resistance is, how much volume it trades, how it has moved in the past, and where it could potentially go in the future.
The hardest thing with technical analysis is trying to decipher which chart patterns are reliable and what indicators make sense. It is very easy to get analysis paralysis from following too many technical indicators and methods that cause indecision and poor investing results. In this post I am just going to touch on chart patterns and save the topic of technical indicators for another day, but the key to technical analysis is to always focus on the basics:
If you learn to read price and volume for whether a stock is really being accumulated or distributed during up and down moves then you can make much smarter decisions with your entry and exit points.
As you get more proficient at reading charts you will start to see repetitive chart patterns that occur and understanding these patterns will help to make you a better investor and trader. The reason these same patterns occur over and over is due to investor psychology and just plain old supply and demand price points on a chart. (Example: As a stock moving up clears a specific resistance price point on volume that means demand has surpassed supply and new momentum money carries it higher)
There are many types of chart patterns but here are some of the most popular and reliable patterns. (I was going to draw out examples of these chart patterns but there are great free resources already out there that I figured I might as well link to them for your review)
MOST PREDICTABLE PATTERNS (continuation and reversal patterns):
- Bullish Symmetrical triangle - a popular pattern that eventually causes the stock to pop out of its tight trading pattern. GREAT PATTERN.
- Bullish Flag / Bull Pennant - very predictable excellent continuation pattern (need volume on breakout) – MY FAVORITE
- Bullish Acending Triangle – popular pattern that can be very reliable if proper volume patterns (Want light volume within triangle and then higher volume on break above triangle)
- Rectangle Pattern – these are obvious when a stock trades in a flat range and is continuation pattern(bullish or bearish) as it breaks out of the rectangle. I find these a little more unpredictable but pay attention to volume patterns within the rectangle)
- Double Bottom – Forms a “w” chart pattern and want increasing volume on 2nd up portion of W pattern. Can be tricky to read on a chart sometimes.
NOTE: VOLUME PATTERNS ARE VERY IMPORTANT WITH ALL THOSE PATTERNS ABOVE. Also, I listed some the patterns above with the term “bullish” because the linked charts showed bullish examples but they are really referred to as “continuation patterns” which means they are chart patterns that occur during a specific direction whether the stock is uptrending(bullish) or downtrending(bearish), so those patterns(except for the double bottom) could just as well be used as continuation patterns in a bear move(downtrending stock)
For other common chart patterns, check out this page
If you want some great, easy to read chart pattern sites, these 2 sites below do a great job summarizing all the patterns quickly for reference and both of these sites have been around a long time:
http://thepatternsite.com/chartpatterns.html (If you scroll down on this page you will see the large number of chart patterns out there)
Summary, don’t get overwhelmed by all the patterns and lines and indicators(I don’t follow most of them). Focus on price and volume patterns for a chart and if a stock consolidates(on light volume) after a big move up, and then breaks out of that consolidation pattern on higher volume then the stock has a higher likelihood of continuing higher. On the other hand, if you saw the consolidation pattern full of choppy high volume and then it breaks out on weak volume, then you know to avoid that stock as it has higher odds of failure and falling back down.
Keep in mind that understanding chart patterns are really useful even if you aren’t buying the actual stocks but just selling options for income credits. You can reference charts to determine where to sell options for credit income.