For investors and traders who want to go beyond dollar cost averaging and dropping lump sums of money into mutual funds and index funds, a basic understanding of stock chart analysis is the first step toward developing trading strategies. The following is a basic overview of stock chart analysis to provide that fundamental understanding.
The heart of a stock chart shows the progression of the stock’s price over a period of time. The price is measured off of the vertical axis, and time is measured along the horizontal axis, from older on the left to most recent on the right. From there, things get more complicated.
The user of a stock chart can select the total period of time being covered by the chart. Sometimes this is through a drop-down menu of common periods, such as one week, one month, three months, or one year. But many stock charting websites and programs will also let the user select custom ranges of data.
The chart will also let the user select (with some limitations) the amount of time that each data-point on the chart will represent. For any period longer than about a week, that period is likely daily. But for traders who are going to be focusing on intra-day movement, the ability to select periods as small as one minute can help to understand the short term fluctuation in the security prices.
The chart can also allow price data to be displayed in more than one way. For long term charts, it might be enough to just chart closing prices over the course of a year to see the general price trend. But many traders also want to know what happens within a trading day. In that case, chart users can select OHLC and candlestick charts. OHLC stands for “open high low close” and provides a way to show all four of those prices in one small bar.
The OHLC price indicator will extend vertically to cover the entire trading period range (whether that range was for five minutes or a full week). On the left side of the vertical bar, there will be a tick mark that shows where the first trade of the day occurred. On the right side of the bar, there will be a similar tick mark that shows where the last trade of the day occurred. In one small symbol, the user knows what the opening price and closing price was, as well as the entire range of prices for the period. A candlestick chart also shows the same full range, but also is color coded to show whether the price moved up or down during that period.
After the price data has been added, many chart users then have a second scale to show volume. The volume for the period shows the number of shares traded. This can be useful data in and of itself (such as if a trader wants to avoid a stock that has very little daily activity so that an order to sell or buy will be filled relatively quickly) and can also be useful when compared to averages for that security. For example, on days when a stock is up or down significantly, that data carries more weight if the stock is also showing heavier than average volume. Some charting software will show a moving average of stock volume overlaid on the volume.
Moving averages are also helpful for the stock price, and frequently a trader will overlay a simple moving average for 20 periods, 50 periods, or 200 periods. When a stock is trading significantly higher than those moving averages, it means that the stock is generally higher priced than it has been in recent history. Likewise, a stock trading below the moving average shows that investors and traders have been selling more heavily than normal over recent periods.
There are a number of additional technical indicators that can be placed on top of the stock chart. As traders gain familiarity with basic stock chart analysis, additional indicators can be added to the traders repertoire to try to divine information from out of the chart. Combining advanced charting techniques with trading and money management techniques serves as the basis for many short and medium term trading strategies.