Stock trading charts are used all the time by traders, but few know how to get the most out of them. Here are five tips on how to use them properly.
1. Don’t skip on research – use charts for confirmation only
Few traders can look at a chart and tell what’s going to happen next. The rest of us have to work at it. And often the price of a stock can take off in either direction at any time, regardless of recent history.
Using a chart without researching the stock you’re considering is dangerous. Even traders who use charts extensively have their ear to the ground to keep informed of developments affecting the price of stocks they have a stake in. Learn everything you can about the stock you’re interested in trading.
Research the company, what it produces, what its main markets are, what problems it is facing, and what projects it has in the pipeline. This isn’t too difficult as most of this can be found online. Once you’ve discovered stock that is under or over valued then consult the chart.
2. Interpreting chart patterns
If you see a pattern make sure it isn’t just in your imagination. Don’t try and see any that aren’t there. If there is one it should jump off the page at you. The main pattern to look for is a trend – higher lows or lower highs. If you can find just one or two established trends each week that you profit from then you’ll do well.
Other patterns include the “head and shoulders”, the “double top” and the “double bottom”. If you see either of the first two on a recent chart then there’s a strong probability that the current movement is generally downwards. The “double bottom” indicates that the price has probably reached as low as it’s likely to go prior to moving up again.
3. Establishing resistance and support levels
These are imaginary lines on stock trading charts indicating where the price cannot seem to rise any higher or fall any further. They aren’t necessarily horizontal – sometimes they can be shown to slant up or down. If the price is moving rapidly towards such a line it will probably breach it and move into a new trading range. Often the line breached becomes the opposite of what it was, i.e. resistance becomes the new support, or support becomes the new resistance.
If the price is moving slowly towards such a line it’s a sign that the price will probably not move much further in that direction and is more likely to reverse.
4. Deciding on your stop loss and profit taking levels
This is where a chart really is essential. If your stock market graph shows a clear trading range outside of which the price rarely goes, then you can set your stop loss and profit taking levels with confidence. This works with medium to long term trading only, where you have sufficient capital to afford sufficient stop loss levels. It can’t be relied on in day trading, where stop loss margins are necessarily narrow and quick profits are sought.
5. Accept your charts’ limitations
If you accept that charts don’t provide a fail-safe way to see into the future, but are simply an aid to making trading decisions, then you will avoid making many of the mistakes that unsuccessful traders make. Those mistakes are usually caused by greed and fear, the two primary factors fuelling price movements in the stock market.
In short, stock trading charts are a priceless asset to any successful financial trader provided you know how to use them and don’t substitute them for doing your homework.
Philip Gegan
