Read Stock Charts: Here's How?

How To Read Stock Charts

We now know the various types of charts that are used to analyze stocks' technicals: candlestick, bar, line, point and figure, and line charts. This section will provide a deeper look at these charts and help you to understand the different patterns used in stock charts.

Essentials to Interpret

Technical analysis is about understanding stock price movements and trade volumes. These are easily accessible. It is important to convert it into a format that can be understood and used for trading.

Technical analysis begins with the creation of stock price charts. The next step is to interpret these charts. This can be done using tools such as momentum indicators, chart patterns, and trend lines. These tools were discussed in previous sections.

This section will discuss some chart patterns that can be used to interpret these charts.

Understanding Stock Charts

Understanding stock charts is the next step after you have learned how to create technical charts. This segment will cover the basics of stock chart patterns and draw important conclusions. Chart patterns can be divided into continuation patterns and reversal patterns. These patterns can be used with all types of charts except point and figure charts.

• Reversal Patterns:

  In other words, a reversal pattern indicates that the current trend in price movements will reverse. This means that if a stock's price is increasing, it will begin falling, and if it starts decreasing, it will rise. Two important patterns are possible to reverse:

• * Head and shoulders, and inverted head and shoulders Three consecutive waves on a stock market price chart create the head and shoulders pattern. This is illustrated below.

  The middle wave is the one with the highest peak. This is the head. The left and right shoulders are the other two. A strong upward pattern is the basis of a head and shoulders pattern. The peak of the first (left-hand) shoulder is higher that that of the rally preceding it. It is marked with very high market volumes. This is followed by a sharp fall, which brings the price back to the starting point. This is marked by low volumes. Next is the creation a head by another larger up-move. Again, it is marked by low volumes. The price drops again, bringing it back to the level of the previous two instances. This is known as the neckline. The third step is the formation of the left shoulder and its subsequent collapse. The price does not rise, and the long-term price falls. The reversal occurs.

(IMAGE 1).

Head-and-Shoulders Pattern

This formula calculates the price target for the reversal (i.e. the price at which fall will cease):

Price target = Neckline prices - (Price at neck - Neckline prices)
Price target = Neckline Price - Head + Neckline Price

The reversal or reversal in an uptrend is indicated by the head and shoulder patterns. It is a reversal pattern so it can also signify a decline. It marks the end to a period of continuously falling prices. This is illustrated by the head-and-shoulders pattern, which is upside down. This is called the inverse shoulder and head pattern. It's the exact image of a water head and shoulder pattern. There are three inverse waves in this example, with the lowest one having the bottom. Below is an illustration. It is displayed below using an example.

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Inverse Head-and-Shoulers Pattern

• Double tops and double bottoms A double top can also occur after a significant uptrend. It contains two waves, instead of the usual three. The price at each peak is the same, unlike head and shoulders. The fall of the trend will eventually reverse if it is longer and more frequent. Double tops have the same target price formula as head and shoulders. Here is an illustration of the double-tops pattern.

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Double Tops

The double top pattern can also be used to indicate the reverse of a downward trend. It is also known as the double bottom pattern. It is a result of falling prices. It looks almost like the water-image of double top. Here is an illustration of the double bottoms design:

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Double Bottoms Pattern

The triple tops or triple bottoms pattern is another variation of the double bottoms and tops patterns. This pattern is similar to the head-and-shoulders pattern but it only has three heads. The shape of the peak, and all three waves are roughly the same.

Triangle pattern:A triangular pattern is created when the stock chart's tops and bottoms are constantly decreasing. If trend lines are placed for tops or bottoms, they will converge. The pattern will appear like a triangle. There are three reasons why the difference between tops & bottoms is decreasing: tops are increasing, bottoms remain constant, and tops are falling. Bottoms are also changing while tops are stable. And tops and tops are converging. These patterns can lead to ascending triangles, descending triangles and symmetrical triangulars. These trends signify the continuation of the trend as a technical chart.
An ascending triangle has highs that are constant and lows that are increasing. Investors are more interested in the stock's lows than the high price. As more investors purchase, prices may rise further. Therefore, the trend is unchanged from before the pattern was created. In a descending triangle, the tops will fall and the bottoms will remain constant. This indicates that investors have little interest in the stock, despite its declining price. This means that the stock's price will continue to fall as more people sell, but little buyers. Tops fall and bottoms increase in a symmetrical fashion. Existing sellers will be keen to sell and buyers will be eager to buy more. The two eventually reach a consensus price. Prices continue to move in the same direction after the formation of the pattern. Below is the figure of a symmetrical triangular triangle.

• Continuation patterns:

  Continuation patterns are a confirmation that the trend that was seen on a stock chart prior to the appearance of the pattern will continue. If the price was rising, it will keep going up. It will also continue moving lower if it was going higher. There are three common continuation patterns:

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Symmetrical Triangle Design

Rectangle pattern A rectangular pattern is created when a stock's prices have been within a certain range. Every up-move has the same top and each down-move has the same bottom. This means that there is no change in top or bottom prices over a long time. You will notice that the trend lines created by constructing a channel are parallel. They create the appearance of a rectangle when they are combined. This means that investors buy the stock at a certain price and then sell it at a different price. This creates clear support and resistance levels. The stock chart will continue moving in the same direction, as it was before, since neither the buyers nor the sellers can decide on its price. Bullish triangles are a rectangle that appears after a long bull market. It is a sign of continued upward momentum. A bearish triangle is a rectangle that appears after a long bear run. It signifies a continuing downward momentum. Below is the figure of such a triangle:

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Bearish Triangle Pattern

Flags and pennant flags are similar to triangles and rectangles, respectively. They are however only visible for a short time. Technical charts are often able to see triangles and rectangles for long periods of time. They can also cause long-term price fluctuations. Pennants and flags, on the other hand, can only be seen in intraday charts. These are usually for a period of one week to ten. Two parallel trend lines are what yield a flag formation. They are caused by tops/bottoms that are increasing/ decreasing at equal rates. A flag formation is usually in the opposite direction to the current chart trend. If the price has risen in the time leading up to formation, then the parallel flag formation will tend downwards. It will still indicate an upward trend, as it did before. The flag will remain upward-bound if the price trend has been downward. It will however indicate that the intraday trend is continuing downwards.
Triangles are very similar to pennants. Pennants are similar to triangles, but pennants can advise on short-term trends.