Stock charts depict the price movement of stocks over time. Charts are created for both individual stocks and for market indices such as the Dow Jones Industrial Average. The use of charts to predict the future movement of stock prices is called technical analysis. Stock market analysts who use technical analysis believe that the charts reveal patterns of price movements that will repeat themselves and can be the basis for successful stock trading.
Look at trading volume -- the number of shares exchanging hands -- as well as price movement. Identify stocks that are rising in price with increasing trading volume. This indicates a growing demand for the stock and a likelihood of further price increases. Avoid buying stocks that are declining in price with increasing trading volume. Combined, these trends are considered negative, or bearish, indicators -- the price will likely to continue to fall because increasing numbers of investors are selling.
Learn how to identify support levels. A stock may decline to a certain level and then start back up, then go back down to that prior level. Because the price does not fall below that level, it is called a support level. If the stock falls below its support level, it may continue downward and reach a new low.
Find resistance levels in a stock’s price trend. A resistance level is a price point that a stock struggles to break through. It might reach that level, fall back and then go back up to the level again. A stock's breaking through its resistance level it is considered a positive factor -- an indicator that the stock will continue to rise in price.
Study the advance/decline line. Technical analysts also track and chart the number of stocks rising each day minus the number that fell in price. If the number rising exceeds the number falling, the advance/decline index will rise. This pattern, if continued, is considered positive. If the index has a falling trend, this is considered a negative indicator for stocks.
Look for repeating patterns. Stocks sometimes trade within a range between their support and resistance levels. Buying the stock at its support level as it begins moving back up and selling the stock when it bounces below its resistance level and starts back down are strategies employed by stock traders who utilize technical analysis.
- Although proponents of technical analysis believe the charts themselves contain all the information necessary for sound investment decisions, it is a prudent strategy to also study a stock’s fundamentals -- sales and earnings trends, industry trends, new products being developed -- before making the decision to purchase the stock.
- Using stock market charts as a guide to investment decisions requires considerable study. Before investing real money based on analysis of stock charts, consider building a sample stock portfolio and monitoring the price trends. Make imaginary buy or sell decisions based on the patterns you identify in the charts, and then see if your predictions are correct. Reading books on the subject is essential as well. You may also want to consult with your financial adviser.
- “Chart Patterns (Bloomberg Market Essentials: Technical Analysis)”; Bruce M. Kamich; 2009
- “Getting Started in Stocks”; Alvin D. Hall; 1997
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