Stock charts used to only be found in financial media and on your broker’s research page, but now it’s difficult to open social media and not see some kind of stock chart. Whether it’s equities, bonds, commodities, or now even cryptocurrencies, you’ll find charts for every type of asset or economic indicator, usually complete with analysis that might look like it’s in a different language.
Stock charts might look intimidating and confusing at first, but clarity kicks in quickly once you understand how to read them. Stock charts come in all shapes, sizes, and colors (literally) and different types of traders use them for different reasons. Some investors eschew stock charts almost entirely, considering the day-to-day movements to be nothing but noise. But for investors with shorter time horizons, charts are an invaluable resource. Today, we’ll break down how to read a stock chart and why so many traders swear by them.
Why Use Charts in Trading
Stock charts mean different things to different people. For a fundamental investor like Warren Buffett, a stock chart probably doesn’t have much meaning. When your goal is to remain invested for decades, ignoring the daily gyrations of the stock market is a virtue. Sure, it might be nice to know the current price trends, but fundamental investors care far more about data points not shown on a stock price chart.
For day and swing traders though, stock charts are a lifeline. It’s often said that trading is more art than science and the stock chart is the canvas upon which technical analysis is painted. Technical traders use the price data of stock charts to find moving averages, technical signals, and entry and exit points for their trades.
Technical analysis isn’t 100% foolproof and many traders have to sort through false patterns or missed breakouts, but no trader sets out with a goal of winning 100% of the time. Technical analysis is used to put the odds in the favor of the short-term trader, which is why so many seasoned market pros still spend hours pouring over the same charts again and again.
Types of Stock Charts
All stock charts have the same basic features. The Y-axis is the vertical line on the left-hand side of the chart showing different price levels. The X-axis is the horizontal line on the bottom of the chart showing different time frames. Between these two axes will be a graph of a particular stock’s price data, which always moves to the right. A well-performing stock will have a graph moving up and to the right; a poorly-performing stock will move down and to the right.
But you passed 9th-grade algebra so you know the basics of charting. What does a stock chart tell you in particular? There are two main types of stock charts: line charts and candlestick charts, each providing a different bit of information:
- Line charts – These are the most commonly used stock charts, but they don’t provide the same level of information as candlesticks. Most line charts only show the closing price for each specific time frame, whether that’s a day, month, or a 5-min period within a trading session.
- Candlestick charts – Often called Japanese candles due to their origination, a candlestick chart functions similarly to the line chart, but candles give us far more pricing information than a single point on a line. Candlesticks can show highs and lows, plus opening and closing prices, all within the same structure. More on these later.
Most brokers offer interactive stock charts where investors can lengthen or shorten time frames, use pre-programmed technical trading signals, or draw their own trendlines and support or resistance levels. Other forms of stock include mountain-style line charts and OHLC candle charts (which stands for Open High Low Close). Stock charts can be drawn linearly or logarithmically and the Y-axis can be used for percentages or absolute values.
Parts of a Typical Stock Chart
Now that we’ve gone over the basics, let’s break down the actual nuts and bolts of a stock chart. Keep in mind that traders have different styles and goals, so not all charts will be equally useful. For example, if you’re a day trader, you likely won’t need a stock chart with 4-hour candles on it. But it’s still crucial to understand all the different components to fully grasp all the information being presented.
- Time Frame – Arguably the most important variable on any stock chart is the time frame. Your broker likely has stock charts with time periods ranging from a single day to a number of decades. The time frame of a stock chart is measured on the X-axis with the individual data points representing prices across smaller time periods. Candlestick charts are better at dividing data points by time frame since you have the candle showing a smaller time frame (1-min to a day or week) overlaid on a much larger frame.
- Volume – Stock charts can easily incorporate volume metrics into their presentation. Many charting tools actually divide their graphs into two: the upper and lower charts. The upper chart shows price data and can be overlaid with trendline, entry and exit points, or inline volume stats. Volume is an important factor in any type of trading since high volume breeds volatility. Lower chart features include other measurements like on-balance volume.
- Candlesticks – The Japanese candlestick is a useful feature for measuring different price data across a smaller time period, like a minute or a day. The candlestick shows the open, close, low, and high of the period, with the thick base of the candle representing the open vs close and the wicks being the low and high. Red candles indicate a lower close than open; green candles show a higher close than open.
- Technical Indicators – Stock charts allow technical indicators to be inserted to better locate entry points and identify trends. On the upper chart, moving averages and Bollinger Bands can be added to smooth out price data and other features like inline volume, price channels, trendlines, or linear regression can be drawn. On the bottom chart lie indicators like Relative Strength Index (RSI), MACD, and various types of oscillators.
- Other Data – Stock chart pages usually have other types of data listed such as market cap, daily volume, average volume over the last 10 days, 52-week highs and lows, dividend yield, or EPS.
How much you’ll utilize stock charts depends on your time frame and goals as a trader. Many buy-and-hold investors don’t bother to look at stock charts at all. When their portfolio overextends its parameters, they rebalance their holdings without needing individual price data. But if you’re a short-term technical trader, you’ll be spending lots of time staring at red and green candlesticks.
It’s also important to understand the limitations of stock charts and technical analysis as a whole. Technical traders don’t wave their hands over stock charts like fortune tellers over crystal balls. Stock charts only tell us about the past, and we apply technical analysis to that data in order to project the future. But it’s only a projection – not a guarantee.
If you’ve ever played poker, you know that the hand with a 60% chance of winning still loses plenty. That’s why gamblers have short memories, stick to their plan, and always play the odds. If you want to utilize stock charts in your trading, you should seek to emulate that mindset. Reading stock charts can give you an edge, but you still need to properly manage risk and know when to give losing trades the boot.