Have you ever really looked at a stock chart?

Technical analysis uses stock chart patterns to make money in the market. Technical charts can be hard to decipher for the uninitiated… with trend lines, candle sticks, and trading channels, understanding charts requires a solid foundation in the anatomy of a stock chart. Are you ready to get “chart smart”?

What is Charting?

Charting is the process of looking at a stock chart to glean information about where it’s going in the future. Just like someone who follows fundamental analysis uses a company’s income statement, balance sheet, and a slew of other financial data to figure out what a company’s prospects are, a stock chart can give a technical trader some hints too.

The distinction between technical investors and fundamental investors is an important one – investors who look at charts think more in the short-term (traders), whereas fundamental analysis (investors) usually takes longer to bear fruit. Technicals usually yield smaller individual gains than a longer-term investor might get from a well-picked fundamental stock, but the frequency of trades is where traders really make their money.

Only around 10% of Wall Streeters are technicians, people who use technical analysis to make their investment decisions. But those ranks are growing.

Even fundamental hedge and mutual funds typically employ traders who are responsible for looking at technicals to follow a portfolio manager’s strategy at the best possible price. That’s largely because experienced traders make money on 90% of their trades.

Finding Charts

Finding good charts is one of the first challenges for investors who are new to technical analysis. While the charts you can find on sites like Yahoo! or Google Finance are useful, they simply don’t provide the shear amount of information that a traders needs to get out of a chart.

If you’re looking for really good real-time charts, lots of services require a subscription fee – but not all.

Your best bet is to turn to your discount online broker. Chances are they provide a real-time charting tool that’s free to use if you’re a client. Otherwise, sites like StockCharts.com and INO.com offer a number of free interactive charts that you can cut your teeth on while you get the hang of charting.

Anatomy of a Stock Chart

So, what’s a chart look like to a trader? Well, take a look at this one:

The first thing you’ll notice is the fact that it’s not a line like most traditional charts – the chart’s made up of a series of boxes called candlesticks. Why the boxes?

Well, unlike a line chart, which only gives you one data point (like daily closing price), a candlestick chart gives you five data points in the same amount of space. In other words, candlestick charts give traders five times as much information as a line chart would.

Candlesticks are especially useful in looking at trends… and after all, trends are an integral part of technical analysis. We’ll take a look at trends next time; for now, let’s look at the rest of this stock chart.

Support and Resistance

Take a look at that support line – it’s a pretty important element of the chart. A stock’s support level is the price that the stock doesn’t want to fall below. It’s like the “floor” for the stock.

On the other end of the spectrum is resistance, the stock’s “ceiling” price. As you can see on the chart above, the price bounced off resistance twice. Bouncing off resistance and support is pretty common because it takes a big catalyst – like an earnings release or a change in market sentiment – to make a stock breakout above resistance or below support.

Now that you know the anatomy of a stock chart, you’re one step closer to start trading, but not so fast. You have to know a thing or two about patterns too – that’s what we’ll look at next time. And if you think technical analysis is your thing, stay tuned – next week we’ll be introducing our first “Trader’s Corner”, where a technical analysis whiz will take you on a tour of what’s going on in the market.

Cheers,
Jonas Elmerraji

February 12, 2009

Jonas Elmerraji

A big-four public accounting alum, Jonas Elmerraji brings his readers extensive expertise in small-cap stocks and broad market moves. Elmerraji’s interest in the market started with an investing course in elementary school – today he holds a degree in financial economics from UMBC and specializes in blending fundamental and technical analysis. Elmerraji has contributed to Forbes, TheStreet.com, and Investors Business Daily among others. He is managing editor of the Penny Momentum Trader, and a co-editor of Penny Stock Fortunes.

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