How to Read Stock Charts

The ability to read stock charts is both an art as well as a science. Interpreting stock charts lies at the core of Technical Analysis. However, since our focus is mainly on Fundamental Analysis, we will keep this discussion basic.

What Stock Charts Can Tell Us — the Basics

Let's take a look at some basic concepts that will help us read stock charts:

• Resistance —
  

  

  The chart for Stryker Corp. (SYK), taken from StockCharts.com, covers a 5 month period. Notice how the price approaches $42 several times, but never crosses it. The $42-level appears to be some kind of ceiling resisting the stock price. Hence, it's called the resistance level depicted by the red line in the graph.

  What causes this ceiling, this resistance? As the price moves towards this level, sellers become more inclined to sell and buyers become less inclined to buy. Supply tends to be higher than demand and that drives the price down.

• Support —
  

  

  Let's look at the SYK chart again. Notice how, after May, the price comes very close to $37 and then jumps up again. It would seem like there was some sort of an artificial floor at this price level. This is called the support level.

  When the price approaches the support level, it is deemed as cheap, and buyers rush in to buy the stock driving up the price from this level.

• Trends —
  

  

  Consider the chart for Middleby Corp.(MIDD) spanning from March - June 2009. MIDD shows a phenomenal 100% growth in just two months. There is an obvious trend we can see after the fact. But would it have been possible to predict such a trend?

  Technical Analysts use what is called an uptrend to predict this. An uptrend is formed by drawing a line passing through at least two lows ... the first low being less than the second one. If you can find more than two lows, the additional points that form the line lend more validity to the trend. The blue line shows MIDD's uptrend. Uptrends can also be used to predict a support-level going forward.

  
  

  

  A downtrend is formed by drawing a line passing through at least two highs ... the first one being higher than the second. The red line in the graph shows a downtrend from Sep to Nov 2008. The downtrend line can be used to predict a resistance-level in the future.

• Moving Averages —
  

  

  Moving averages are simple to use chart analysis tools. A 50-day moving average seems to be most popular. The blue line in the GOOG chart shows the 50-day moving average. Each point is the simple average of the price over the previous 50 days.

  Moving averages give us important clues on the price-trend. In the chart above, the stock price falls below the 50-day moving average in mid-June, signaling a potential drop in price going forward. Sure enough, GOOG suffered several months of staggering declines in its stock price.

In summary, we've taken a basic look at interpreting stock charts. We looked at some important charting concepts — resistance, support, trends, and moving averages. You're now ready to get started analyzing charts. The more you read stock charts the more familiar you will become with these concepts. You can then move on to more advanced charting concepts.

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