Understanding Stock Charts - A Few Basic Tips
Stock charts can provide a wealth of information if you know what to look for. Stock charts also come in many different forms, styles, and types, but a few basic charting skills can be used universally across all charts. In addition, when used in conjunction with other stock indicators these basic charting skills can help you greatly improve your trading results.
Some of the most important pieces of information that can often be determined from charts are support and resistance levels. Resistance levels are price levels that a stock has a difficult time passing through. The support level is called a floor while the upper resistance is called a ceiling. Basically, what happens at a floor (support) is buyers enter the market around the floor price to stabilize the price and possibly drive the price back up. When a stock is reaching its ceiling, sellers enter the market stopping the upward momentum and possibly drive the stock price back down. The best way to spot support and resistance levels on a stock chart is to find prices where the stock moves sideways. For example, if a stock is trading around 35 and then trades down to 30 but then begins to move sideways at 30 and eventually heads back up in price, then 30 is probably a price support. The more times a resistance level is tested, the stronger it becomes. However, if a resistance or support level is broken it often becomes resistance or support in the opposite direction. For example, if the stock mentioned above broke through its price floor of 30 then the price floor would become the price ceiling. Keep in mind that support and resistance levels are usually price ranges not a specific stock price.
Another important feature of stock charts is volume (the number of shares traded each day). Most stock charts will show the volume of shares traded along the bottom of the chart. Look for higher than normal trading activity. If a stock is trading higher on high volume it is much more likely to continue. However, if a stock is trading higher on low volume, it may be a sign of uncertainty and the gains may be short lived. Without the conformation of volume it is very difficult to be sure of any price move or new trend.
A third important chart feature is a gap. A gap is when a stock "jumps" up or down leaving a blank area on the chart. For example, if a stock closed the previous day at $26 but then opened the next day at $28, this would be a gap up. In this example the gap will become a resistance floor. However, if the gap is penetrated, it will often fill the entire gap or close the blank space before resuming its trend. Once the gap has been closed it loses much of its significance on stock charts.
When using stock charts, you should consider them as a basis for information. Before trading you should considering using other indicators to confirm the validity of your observations. Also, keep in mind that using stock charts can be a helpful tool but stock charts use historical data and future price movements may differ. However, most active traders rely heavily on stock charts and indicators to make their investment decisions.