However, all stocks must contend with an underlying price, determining a company's value. While price is a product of supply and demand for the stock, price action analysis is called "technical analysis." Price action is analyzed with stock charts to gauge where a stock has been and where the price can go.
If you've ever wondered how to read stock charts, you came to the right place. We'll help you interpret the basics of reading stock charts to help you make informed decisions on your stock investments.
What is a Stock Chart?
A stock chart plots the price action of a stock. You can use it to gauge the history of the price action to determine the potential direction and magnitude of future moves by assessing price inflection points. You can plot stock prices on charts ranging from the popular candlestick chart to a bar and line chart. Read on to learn more about how to read a stock chart.
Why Should You Analyze Stock Charts?
While it's essential to do your research and understand the underlying company's fundamentals for a particular stock, it's also crucial to understand the price action. You can correlate a stock price to the performance of an underlying company; they can be two separate beasts. A company can perform very strongly with a great earnings report, only to have the stock price fall and vice versa. Price action doesn't always correlate with a company's performance in the short term. Understanding price action can help you understand the reason for the moves.
Key Concepts of Analyzing a Stock Chart
There are many methods of analyzing a stock chart (aka learning how to read stock market charts). However, the key concepts generally remain the same. Remember that the goal of reading a stock chart is to derive information about the price action to assess the potential direction and magnitude of the move in the future. Price action often precedes the news and reflects the stock's overall sentiment. Stock prices move on "no news" and with news. The broad stock market climate can impact your stock price, whether it's a rising bull market or a falling bear market. Here are the basics to understand.
Price Support and Price Resistance Levels
All stocks have price support and price resistance levels. Supply and demand determines price. There are various price levels where more buyers are willing to buy than sell and determined a price support level. The areas with more sellers than buyers determine a price resistance level.
Assess Potential Future Price Moves
As they say, history tends to repeat itself. Like everything in nature, the markets also have muscle memory. Certain price patterns repeat themselves through the stock market. Knowing the history of price action trends and patterns can help assess future price direction and movement.
React, not Predict
The purpose of reading stock charts is to prepare yourself for the potential moves to specific price inflection points so you can react. It's a game of probability, not predicting. It's the difference between anticipating a freezing 10-degree day in July in California and responding by turning on the heat, as opposed to predicting an anomaly that the temperature will fall to 10 degrees on July 8 with blinders and getting disappointed when the temperature stays in the 80s.
Reading stock chart is a game of probabilities, nothing is 100%. When specific price patterns repeat, it is highly likely to move in a particular direction by a certain amount of points. However, even a 90% probability has a 10% chance of failing. Any one assessment can be random, but after enough assessments, a clearer picture and probability tend to materialize. When reading charts, expect everything to be less than 100% in the stock market.
Stock Chart Components
Technical analysis shows how to read charts and graphs for stocks. Every stock chart has basic components to it. You can add indicators to help read charts and find price patterns. Let's go over the features of a candlestick chart
Rice traders first used candlestick charts in the east. Steve Nison first introduced the concept to western civilization. Rather than making a simple plot representing a price, a candlestick represents four pieces of information per trading period. That is the opening, the highest, the lowest and the closing price. The open and close form the body and are colored in red for a lower close or red for a higher close. The highs and lows illustrate tails or wicks. Together, they look similar to a candlestick.
For a five-minute candlestick chart, each candle represents the opening price of the first trade for that period, the highest price traded, the lowest price traded and the closing or last price traded during the time period. If a candlestick is painted red, the open price is higher than the close price, meaning more selling pressure has pushed down the price.
A green candlestick means the close price is higher than the open price indicating more buyers helped to lift prices. The wicks or tails represent the highest and lowest prices during that time. These four components work into every candlestick. The candlesticks are viewed throughout the day to gauge price patterns.
Every stock chart has a timeframe with period price data to help you learn how to interpret stocks. Timeframes can range from one, five and 15 minutes to a daily, weekly and/or monthly chart. The timeframe represents the intervals for each data point. A 15-minute chart will plot the price action for each 15-minute interval, whereas a weekly chart will plot the price action every week. It doesn't mean the chart is 15 minutes long or a day long; the timeframe is the interval of each period in the chart.
X and Y Axis
Every chart has an X and Y axis. The X axis has the dates and the Y axis contains the price scale. The axes pinpoint the resulting price action for a particular date. Each date serves as a data point amassed together to gain a complete picture of the price action for a period of time.
Periods are the number of intervals for each plot on a chart. For example, a daily chart with a 200-period moving average represents a chart plotted daily with dates on the X-axis, price on the Y-axis and a moving average derived every 200 days for a single plot. The average closing price of a stock for 200 days is then continuously plotted on the chart and connected to form a moving average line.
As the name states, a moving average (MA) is the average price calculated by the number of specific periods plotted on the chart and connected to form a continuous line. For example, a 15-minute, five-period moving average plots the average price for every five of the 15-minute interval price data on a 15-minute timeframe chart. People use moving averages as a dynamic price support or resistance level. A simple moving average is often used with different periods to determine supports and resistances. Moving averages can vary from exponential to weighted moving averages that factor in volume. A commonly used moving average is the 200-period moving average. When used on a daily chart, it's referred to as the 200-day moving average, widely used as a support or resistance reference point for stocks in the news. Using two moving averages such as a five-period and 15-period MA can help spot price breakouts and breakdowns as the lead five-period MA crosses over/through the laggard 15-period MA.
Breakouts and Breakdowns
A breakout precedes an uptrend. Breakouts happen with price surges through a resistance level or upper part of a range to start making higher highs and higher lows. Breakdowns are the opposite, where price falls under a support level or lower trading range and starts to make lower lows and lower highs.
A stock price is always in one of three potential modes. An uptrend means a stock makes higher highs and higher lows, illustrated by rising moving averages with each period showing a higher high price and a higher low price. A downtrend is the opposite, where each candlestick shows a lower low of the candlestick price and lower high price of the candlestick. When there are no continuous higher highs or lows, it's in a consolidation mode where the stock "rests" in choppy price action until it tries to break out to an uptrend or break down to a downtrend again.
Price support is a price level that continues to deflect attempts to fall below it. It indicates buyers waiting and willing to absorb selling at certain price levels. Supports are good levels to buy on pullbacks. A stock has multiple support levels. Some levels have to be plotted as support when it holds multiple price breakdown attempts. These can be eyeballed on a chart and plotted with a trend line. You can use moving averages to determine price support levels.
Price resistance levels are price levels with enough sellers to prevent the price from rising through it. Resistance levels can often be used as price targets on uptrends to sell your stock. Resistance levels indicate prices with too many sellers that can absorb all the buying to prevent prices from rising higher. Stocks have multiple resistance levels that can be plotted with trend lines and/or moving averages. Remember that each timeframe can have its own price support and resistance levels. The widest periods and timeframes usually have the strongest support and resistance levels. For example, a weekly 200-period resistance tends to be much stronger than a five-minute 200-period resistance.
Stock charts can also track the volume indicated by the date, usually in a bar format. Volume determines the strength of a breakout or breakdown, as heavy volume implies more pressure in a particular direction for the stock price. Volume is often a good sign of liquidity, enabling better pricing with tighter bid and ask spreads. Be careful with low-priced stocks, as they tend to have less liquidity and carry more risk. Consider sticking with the best stocks for $5 or less.
Advanced Stock Chart Terms
Here are some of the more advanced terms you may find regarding stock terms and analysis and learning how to read stock market reports.
- Bid and ask: The bid is the price buyers are willing to pay for a stock. Usually, people tend to sell their stock at the bid price. The ask is the price sellers will sell you the stock. Usually, people tend to buy at the ask price. Prices fluctuate throughout the market trading day as the bid and ask prices rise when there is buying pressure and fall when there is more selling pressure.
- Beta: Beta as a volatility ratio that compares to the S&P 500 benchmark index. A beta of 1.0 indicates the stock usually trades in line with the S&P 500. A beta above 1.0 indicates the stock tends to be more volatile than the overall market. For example, a stock with a beta of 2.0 typically moves twice as much as the S&P 500 based on its price history. If the S&P 500 is up 1%, a stock with a beta of 2.0 should be up 2%. Here's a list of FAANG stocks with high betas for more risk-average investors. The most active stocks, dollar-for-dollar, tend to have some of the highest betas. A beta under 1.0 moves slower than the S&P 500. For example, a stock with a 0.5 beta tends to move half as much as the overall market on any particular trading day. Low beta stocks have less volatility and have less risk versus high beta stocks. Older investors commonly invest in blue-chip stocks with low beta and dividend payouts.
- EPS: EPS is the earnings per share ratio derived from dividing the company's earnings by the number of outstanding shares. For example, a company that made $1,000,000 in profits with 5,000,000 shares outstanding had an EPS of $0.20 per share. Analysts have a consensus of what they expect a company to earn using EPS per share. Companies that report better than estimated earnings per share tend to get rewarded with higher stock prices unless they lower their guidance for the next quarter to a lower EPS.
- Ex-dividend date: The ex-dividend date is when a dividend distributes to its common shareholders on record. Preferred stock owners should know how preferred stock is different from common stock.
- One-year target estimate: The one-year target estimate is a price prediction of where a stock price can go one year later. These are predictions (mostly best guesses), even from highly regarded analysts. Take them with a grain of salt. No one can predict the future, much less quantify it by price.
How to Analyze a Stock Chart
Once you understand a stock chart's concepts and components, it's time to put them to use. Analyzing a stock chart means interpreting the price action. Regarding price action, there are three things to gauge: trend, support and resistance. These three pieces of information are the basis for price patterns and all price interpretations.
Step 1: Determine the trend.
First, observe the direction of the trend. Is the stock price rising on the chart with higher highs and higher lows? If so, it's an uptrend. If the five-period MA and 15-period MA are both increasing, then that helps to confirm and illustrate the uptrend.
Vice versa, if the five-period MA and 15-period MA are both falling as the stock makes lower lows and lower highs on bounces, then it's in a downtrend. The combination of moving averages should be a lower period and a higher period. Some of the more commonly used period combinations are the 5/15, 20/50 and the 50/200-period MAs.
Step 2: Find supports.
With moving average charts, the lead moving average is the smaller moving average and it acts as a support if the price is rising. The lagging moving average is a secondary support on a rising stock. For example, a 20/50 period MA chart would have the 20-period MA as the support and 50-period MA as the secondary support on an uptrend.
You can also plot supports using historical price levels that have successfully absorbed selling and cause the price to bounce back up. If a price level holds on two separate occasions with wide intervals, then it can be a double support level. Support levels that break down can turn into new resistance levels as a downtrend forms to lower the stock price.
Step 3: Find resistance.
If the price falls, causing the 20-period MA to cross over through the 50-period MA, it has turned into a downtrend. The 20-period MA is a resistance and 50-period MA is a secondary resistance as the stock makes lower lows and lower highs on bounce attempts.
If a stock historically rejects certain price levels, you can plot a horizontal trend line as a resistance level. This would be a level to sell any positions and not chase entries. A new uptrend to a higher resistance level is possible if a resistance level breaks out. Resistance levels that break out can turn into new support levels as price uptrends to new resistance levels.
Step 4: Anticipate entry and exit targets.
Knowing where there are support and resistance levels along with the direction of the trend, you can use this information to take action. You can pinpoint certain price levels that you may want to enter or add to a stock position near supports. You can identify certain price levels to exit part or all of your position in a stock based on the resistance levels ahead. These three pieces of information, including trend, support, and resistance, can help interpret stocks and help in understanding stock graphs.
Make More Informed Decisions
The purpose of investing or trading is to make profits. Since stocks are valued by their prices, it only makes sense to learn how to read stock charts. Along with fundamental research learning about business operations and performance, understanding the price action is all part of a balanced research process. The purpose of fundamental and technical analysis is to derive the knowledge needed to make more informed decisions regarding your stock market investments.
Here are some answers to more frequently asked questions about reading stock charts.
How do you analyze a stock chart?
Select the type of chart and timeframe, like a candlestick chart on a weekly timeframe. Use indicators like moving averages to visualize the trend and spot support and resistance levels. Plot horizontal support and resistance trend lines are price levels where the price has deflected several times.
What does a stock chart tell you?
A stock chart interprets the price action, which gives you a visualization of the trend or direction of the stock price and the various inflection points where the price is held as support or rejected as resistance. The trend provides the stock's sentiment while support and resistance provide entry or exit target levels if you decide to move.
How do you read stock trends?
You can eyeball the candlestick charts for uptrends, which are rising higher highs and high lower candles, or downtrends, which are falling prices indicated with lower lows and lower highs. The easier way is to use two moving averages to visualize the trend and provide quantitative support and resistance price levels.