How To Read Charts

Learning how to read a chart is the cornerstone of every successful trading experience.

When I first started trading stocks, I had no idea what a good chart was. Looking back now, I lost a good amount of money investing in companies that I wouldn’t touch with my worst enemy’s bank account. I thought that any chart pointing upwards was an easy buy and I would just follow that train to gravy town. The worst part was – sometimes I did!

Gravy town sounds great… right? The problem was that I was getting lucky instead of getting good. There is a thin line between gambling and investing in companies that you believe will succeed based on independent research and widely accepted variables. In fact, there may not be a line at all – but one is definitely classier than the other. The shortcuts never pay off and although getting lucky doesn’t seem like a shortcut, it’s really just bypassing the work needed for a quicker result. Like all things, once the shortcut pays off you have to keep using it to maintain the momentum. This is where I made the most of my mistakes… Que the infamous dumps and humbling reverse-splits, but that’s another blog post.

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Being able to read a stock will help you forecast what might actually happen and hedge your investments accordingly. Not every investment is going to profitable, but there is comfort knowing that some unforeseen factor robbed you, instead of your own stupidity.

Everyone can agree that a good stock needs to be showing upward momentum. However, how do you distinguish between a fluke and a golden goose?

The simple answer is to look at the bigger picture. Actually, keep looking at the golden goose until you find its flaw and then be extremely critical of it. If you can’t find a flaw, you’re not looking hard enough – or it’s an IPO (Avoid IPOs like the plague). Next, you want to gauge the impact of the flaw and its timeline. The stock hit rock bottom 5 years ago? It could be under new management or could have done a forward-split. For instance, Amazon nearly lost everything after they underwent a forward-spit and the stock price dropped to an all time low. In their case, nothing about the company changed except the liquidity of their shares available in the market. Since that event, Amazon has not split their stock in any direction. Make sure you understand the WHEN and the WHY before considering an investment.

The next step is to evaluate if the lowest high is higher than the highest low. That basically means that the chart should resemble a set of stairs. If the chart has huge peaks followed by even bigger valleys then you should seriously reconsider. The steps indicate steady growth and support lines at each price point. Remember that the chart is just a representation of the price and ultimately what the market values the company at. If the stock is rising and like a set of stairs, then the assumption can be made that the market as a whole agrees with the current valuation of the company. However, if the stock is bouncing up and down then it’s clear the market doesn’t agree on the company’s value. This is critical – don’t try and be a savior on the stock market. Do not fight the market because you’re convinced the company will turn around eventually.

There are several methods to analyzing a chart. Sometimes I use trend lines or other graphs, but the fool proof way is to turn it upside down. That’s right – turn your phone or computer upside down. If the chart doesn’t look good upside down then it’s a bad chart. I picked up this technique early on when I realized I was getting suckered into thinking I could sell my shares at a point higher than the highest point (HOD). By turning the stock upside down you are able to determine if selling at a (Realistic) low point is still profitable.

A good chart should have very little range between the low points. For example, imagine a stock valued at $100 begins to rise everyday until it reaches $200. Realistically, it will probably hit $200 several times before it settles on the valuation. This is because there is a large amount of people willing to pay $200 to own a piece of that company. However, if you look at the stock and the difference between the lowest points each day was $10, you can begin to trend smarter. Everyone wants to buy a stock at $100 on Monday, sell it for $150 on Tuesday, buy it back at $130 on Wednesday, and close the week out with a $200 sale on Friday. This does happen and you’ll get there eventually. There have been times when I “played” the same stock for weeks doing exactly that while it settled into the market valuation.

Again, this is for people starting their journey as an investor and is crude compared to the indicators and tools available with some of the more sophisticated programs.

Please feel free to leave a comment or reach out to me directly if you need additional clarification. The goal is to take a library of investing experiences and transcribe them into a library of articles that are helpful and informative.