A stock chart is a graphic representation of a stock's price and volume action. Charts help identify the price changes in the share price of a company over time. Although daily, weekly and monthly charts are used, daily charts are the most useful for reading chart patterns.
Why Do Chart Patterns Form?
Charts reflect what investors do, not what they think or say. Investor decisions are driven by emotions such as fear, greed, hope and pride; and to the extent that human nature does not change, chart patterns recur even though the market participants change.
When a stock forms a recognizable pattern, a chart can show what other stocks in a similar situation did when they moved out of those patterns. Several books on technical analysis, as well as online charting services, provide extensive chart pattern descriptions based on historical studies. There are dozens of well-researched chart patterns that work with varying degrees of accuracy.
Learn Chart Patterns
The first step is to learn chart patterns and what they mean. The second is to learn how to recognize those patterns in new daily stock charts -- it takes practice.
A chart pattern has little predictive value until it is completed. Charting is not a precise science as one chart pattern may evolve into another. Different chartists may use different terms and time frames in their interpretations. For example, a head-and-shoulders pattern may also be viewed as a rounding top; a small cup-with-handle pattern may constitute a large handle in another, much larger, multiyear cup with handle.
Importance of Volume
A stock's daily trading volume is vital for validating a chart pattern. A constructive chart pattern must be confirmed by volume. Volume should generally move with the trend, meaning that a stock in an uptrend should rise on higher volume and fall on lower volume.
Every chart pattern has a point, called a pivot, beyond which the stock seems unable to go. A stock moving through that pivot on high volume constitutes a breakout -- the beginning of a move of significance. It is important to learn to identify pivots in various chart patterns.
When investors recognize a strong chart pattern and identify the correct pivot, they watch the stocks carefully. The moment the stock breaks through the pivot on high volume, investors often choose to buy because they believe this signals that the stock is poised to move higher.
- "Technical Analysis of Stock Trends"; Robert D. Edwards, John Magee; 2010
- David Silverman/Getty Images News/Getty Images