Investing > How to Read Stock Charts

How to Read Stock Charts

Stock charts are crucial for technical stock analysis. This guide will help you read them like a pro.

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Updated November 19, 2020

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One of the most important things an investor needs to learn is how to read a stock chart.

Knowing how to read stock charts is an essential skill if you are going to perform any kind of technical analysis. Even if you’re more of a fundamental or value investor, being able to accurately decipher stock charts is incredibly useful for figuring out when to buy or sell.

That’s why we put together this simple guide to reaching stock charts. We are going to cover the main types of stock charts out there and talk about what kind of technical analysis they are good for.

Before we get started, one quick note: all images used in this article come from Yahoo Finance. We picked Yahoo as its interface has a broad suite of technical analysis tools and it’s free to use.

What is a Stock Chart? 📈

In short, a stock chart gives a visual representation of the performance of some company stock.

Here is a simple example of a stock chart. We will use Microsoft for this example.

Picture of a stock chart on Yahoo finance
Charts are meant to provide you with a comprehensive overview of all the crucial stock features.

This chart represents the stock price for Microsoft over the past year. Let’s dissect the anatomy of the chart.

The solid blue line is known as the trend line. The trend line represents the current value of individual stock in the company.  As you can see, it makes a lot of dips and peaks, which corresponds to the fact that stock prices rise and fall over time.

The recorded value of the stock price on the line corresponds to the closing price for that stock on that day. If you move your cursor over the chart in the application, a small box appears that gives info about the day’s opens, highs, lows, closes, and volumes.

The purpose of the trend line is to help you identify trends in stock prices so you know when a particular stock is growing and when it is falling. Trend lines become the most useful when viewed over longer periods of time. Compare the above chart with this one:

Picture of the performance chart on Yahoo Finance
Performance charts give you an overview of company’s progress in years behind.

This chart shows the performance of Microsoft stock over the past 25 years. As you can see, Microsoft really began to take off around 2000 and has shown continual growth ever since. Bet you wish you’d invested in Microsoft 20 years ago, huh?

If you look closely near the bottom, you will see black boxes marked either “S” or “D.” These points represent stock splits and dividend payouts. Again, as you can see, Microsoft only started paying out dividends to investors around 2003. Microsoft pays dividends to its investors every 3 months.

Often, large peaks or spikes in company stock match up with events in the company’s history. For example, you can see that Microsoft stock reached a peak in 2000 at $58.38 per share.. This coincides with the software giant’s dominance over the PC operating systems market at the turn of the Millenium.

After the dot.com bubble burst, Microsoft’s stock value stagnated for almost 13 years before reaching a new peak in 2016. The more recent spike corresponds to Microsoft’s pivot to cloud-based applications.

Knowing how to read a trend line is probably the most fundamental part of reading a stock chart.

Types of Stock Charts

The type of chart we were looking at above is called a line chart. A line chart is the simplest kind of stock chart but, on its own, a trend line does not give much information. Trend lines and line charts are good for showing long term patterns but are not as useful for short term analysis.

Aside from line charts, there are 3 major kinds of stock charts, bar charts, candlestick charts, and point & figure charts. We will cover each in turn.

Bar Charts 📊

A bar chart shows four crucial pieces of information: Opening price, highs, lows, and closing prices (OHLC). At each day, the vertical line represents the range of the stock that day while the left-facing horizontal line represents the day’s opening price while the right-facing horizontal bar indicates the stock closing price. The particular chart shows the opens, highs, lows, and closes for Microsoft stock over the past 3 months.

Picture of a bar chart on Yahoo finance
Bar charts provide traders with crucial info for trend reversals and securities’ volatility analysis.

Bar charts are particularly useful for analyzing trend reversals and monitoring how volatile some security is. If most of the vertical lines are very long, then that means that the stock value can fluctuate wildly throughout the day. Conversely, small vertical lines mean the stock is relatively stable over that period.

If the close is above the open, it means buyers were more active, which could indicate that there will be more buying in the near future. Bar charts are probably best suited for short-term investors as they can give you an idea of how much you can expect a stock to grow over a short period of time and how volatile the security is.

Candlestick Charts 🕯️

Candlestick charts are extremely similar to bar charts and show most of the same information, just in a different visual style. Like a bar chart, candlestick charts show the open, highs, lows, and close for a particular stock. The thin black line behind each colored box is called the “shadow” and shows the range of the stock price over the day.

Picture of a candlestick chart on Yahoo finance
Candlestick and bar charts differ in visuals but provide the same information.

The colored area is known as the “real body’ and measures the difference between the opening and closing price of the day. If the close is higher than the open, the real body is colored green and if the close is lower than the open, the bar is red.

Candlestick charts have been used for centuries and were first developed in the 1700s by a Japanese man named Homma. Homma reasoned that, in addition to supply and demand, the market’s behavior was influenced by human emotions.

The purpose of the colors in a candlestick chart is to visually represent that emotion using different colors. Investors use candlestick charts to track patterns and make predictions about the short-term direction of the stock.

Point & Figure 👉

Point and figure charts are a separate kind of chart meant to plot price movements of securities. Unlike line, bar, and candlestick charts, point and figure charts do not plot an asset’s movement with respect to a time-axis. Instead, P&F charts use Xs and Ox to represent price movements.

Picutre of a point and figure chart
Point and figure charts are designed to plot price movements without referring to time.

Each X and O refers to a price movement. An X is marked when the price increases by a set amount and an O is marked when it decreases by a set amount. The set amount is called the “box size.” The amount of the box size differed depending on the stock and the individual investor’s preference.

For instance, a common box size to use is $1. If the price rises by $1 then an X is created. If it drops by $1, an O is created. A new column is added when the prices reverse by a determined amount, known as the “reversal amount.”

Again, the reversal amount is determined by the type of security and investor preference. A common reversal amount is three times the box size, for instance.

P & F charts are useful because they give data about price movements but remove all the noise and fluctuation that occurs when measuring over small time intervals. Investors who favor P&F charts say that they help them identify true trends and breakouts and that they are less susceptible to perturbation from small price movements.

What is Volume? 🤔

There is one more important concept we want to cover. Nearly every stock chart you look at will have some information about the volume.

The volume refers to the total amount of stocks that are bought and sold over a day. Volume is an important technical indicator as you need to know exactly how many shares change hands every day.

Significant market movements are caused by high volume trading days. High volume trading can be triggered by all kinds of things, including company announcements, the release of new products, or a company’s earnings report.

🛎️ It is important to keep track of volume levels as that can tell you when a stock is about to break through its current equilibrium. Volume also tells you how significant the day of trading was.

You can calculate the volume of a trading day by just tallying up the number of times shares changed hands that day. Say, for instance, that Trader 1 buys 700 stock, Trader 2 sells 1000 stock, and trader 3 buys 2000 stock. Then the total volume for that trading sequences would be 700 + 1000 + 2000 = 3700.

Keep in mind that the volume increases whether or not it is a buy or sell order. Any time a share changes hands, that transaction is counted in the volume.

Volume is an important technical indicator as it gives an indication of how much stock is going to change in value. The majority of stock market transactions are performed by big investment firms like investment banks, mutual fund managers, ETF fund managers, and other large institutional traders.

These investors tend to make very large purchases of sales of stock. These large purchase or sales is what moves stock prices higher and lower.

It is common for millions and millions of stock to be traded every single day. For example, as of the time of writing, the current daily volume for Bank of America alone is over 24 million. That means that Bank of America shares have traded hands over 24 million times just today, and the day is not even halfway over yet.

Given that the current value per share of Bank of America (BAC) is around $34, that means that over $800 million of Bank of America Stock has changed hands just today.

Here is another figure that will make your head spin: the daily volume yesterday for the NASDAQ was 2,435,228,957 with a total dollar volume of $124,301,111,371.

Over $100 billion of stock changed hands on the NASDAQ alone yesterday, and that is not even including other major stock exchanges like the New York Stock Exchange (NYSE) and the Chicago Stock Exchange (CSE).

Average Daily Trade Volume 📔

Volume can be calculated based on the day or as an average over some period of time. The Average Daily Trade Volume (ADTV) is an average measure of daily volume. ADVT is often a more important metric than daily volume as it gives a big picture view that helps you identify trends rather than relying on a one-off day of high volume trading.

So say for example that the total volume for a particular company over a 30-day period was 750 million. The ADTV would be 750 million/30 days = 25 million.

⚠️ ADTVs is important to track as they let you understand the power of influence over a given stock. If you notice that ADTV for a particular security is increasing, then that could mean the security has higher liquidity as more buyers and sellers are in the market for it.

Conversely, if ADTV is falling, then that could mean investors are becoming more hesitant to trade in that stock. In general, if a security has a high ADTV it means it is more competitive, has narrower price spreads, and that it is less volatile to rapid changes.

Volume Patterns 4️⃣

There are 4 major volume patterns you should look out for. Each of these patterns gives hints as to the future pricing direction of a given security.

  • High volume up days: These are days where there is a lot of trading and the price of some security has increased. This pattern is usually considered a “bullish” indicator and means that the stock will continue to rise as more traders are in the market.
  • Low volume down days: These are periods where volume is low and the stock price drops a bit. This pattern is also usually taken as a bullish indicator. The reason why is that when the stock drops a bit and there is not much trading going on, it means the drop in price is likely a small fluctuation or correction and does not hint at some future price direction.
  • High volume down days: These are days with a high volume of trading but where the stock price drops. High volume down days are considered a “bearish” indicator and usually mean that investors are aggressively selling stock.
  • Low volume up days: This pattern is also considered a bearish indicator. It indicates that trading action on those days is less significant and that price jumps are likely due to small fluctuations or corrections, not genuine price movements.

Common Technical Indicators

Having a stock chart is pretty useful on its own but even more useful if you know how to use technical indicators. In the past, using technical indicators would require you to go in and crunch the numbers yourself. You would have to gather pricing data, perform the calculations by hand, and then interpret your results.

Thankfully, the internet has made using technical indicators so much easier. Pretty much any website that lets you view interactive stock charts has some suite of technical indicators you can activate with just the click of a button. These indicators usually get overlaid on the main stock chart so you can easily see where they are supposed to apply.

Even if you focus primarily on fundamental analysis, if you are going to get good at stock trading you will need a solid command of some key technical indicators, Here are some of the most common technical indicators, what they mean, and how to use them.

Moving Average ✅

Most stock charts are jagged and make hug jumps up and down. It can be a bit difficult to gauge the actual price movement of a security with all the random fluctuation and noise in chart data. Moving averages are a way to smooth price data out into a single flowing line.

This moving average represents the average price of a security over a period of time. The time frame used to calculate the moving average depends on investor preference, but the most common time frames used are 50, 100, and 200-day moving averages.

This chart represents the pricing of Microsoft stock over the past year. The purple line denotes the moving average. In this photo, the moving averages were calculated over a 50-day span.

Notice how the moving average follows the general direction and shape of the blue pricing line. This makes sense; after all, calculating moving averages is basically just smoothing out this line to capture the most important data points.

Moving averages tell us about the general pricing direction of a security. If the moving average is mostly a horizontal line, then the price is considered ranging, not trending. If it is angled upward, that signifies an uptrend is underway. If it is angled downward, then it means the price is undergoing a downtrend.

A single moving average by itself is not incredibly useful as it basically just summarizes pricing data from the past. You can use different moving averages in conjunction to identify key signals.

A crossover involves plotting a 200-day and 50-day moving average and finding where they intersect. When the 50-day average rises above the 200-day average it is a buy signal. When the 50-day average drops below the 200-day average it is a sell signal.

picture of a crossover moving average chart
The crossover moving average charts allow you to analyze more than one moving averages.

In this picture, the purple line is the 50-day moving average and the red line is the 20o-day moving average. The blue and red arrows indicate points where the 50-day average fell below the 200-day average and where the 50-day average rose above the 200-day average.

This method is a good way to judge buy and sell signals because it is more resistant to fluctuations and noise in the data. Using moving averages helps you distinguish real pricing trends from false signals.

There is also what is called an exponential moving average (EMA). An EMA places a greater weight on recent price points so that the line reacts more significantly to price changes. Unlike a simple moving average, an EMA does not give all observations equal weight.

EMAs are useful for identifying more short term trends. Common EMA time-frames used are 20 and 30-day EMAs.

It is believed the EMAs give a more immediate picture of the market and simple moving averages are known to lag behind actual market activity. By the time a simple average line moves enough to indicate a significant trend, the best time to enter the market has already passed.

Since EMA graphs are more sensitive to nearby changes, the line follows the price action a bit more faithfully and reacts more quickly to changes.

Relative Strength Index (RSI) ✅

The Relative Strength Index is an indicator that measures the size of recent price changes. Originally introduced in 1978 by J. Welles Wilder Jr., the RSI is used to tell you if a particular asset is being overbought or oversold. RSI is usually measured as an oscillating line that hovers between two extremes of 0-100.

picture of the RSI chart
Traders use RSI charts to locate the assets that are overbought or oversold.

In this picture, the RSI is represented by the purple line at the top. Traditionally, an RSI above 70 means that the security is overbought and an RSI below 30 means that the security is being oversold. An overbought security means that the security is priced above its true value and an oversold security means that traders believe a stock is selling below its true value.

The RSI can be calculated via a 2-part formula. The first part uses the following formula:

RSI₁ = 100 – [100 1+ average gain average loss]

The average gain or loss is determined over an initial look-back period. The standard technique is to use 14 periods to set the initial RSI value. One there are 14 data points available, the second part of the RSI can be calculated as follows:

RSI₂ = 100 – [1001+previous average gain*13+ current gain average average loss*13+current loss]

The point of the second part of the calculation is to smooth out the RSI line so it is easier to read. The RSI line is then plotted next to the trend line.

The main idea behind the RSI is that it measures the velocity and magnitude of directional pricing movements. The higher the ratio of higher closes to lower closes, the higher the RSI which means more stronger positive changes.

If a particular security hovers below an RSI of 30 or above an RSI of 70 for a while that is taken to mean a pricing reversal is likely. Specifically, the larger the divergence between the RSI and pricing action, the more like that a market turning point is imminent.

Like the majority of technical indicators, RSI charts are more accurate over longer periods of time. Spreading out the time frame helps you avoid false signals. RSIs are most useful in oscillating markets where the price alternates between bullish and bearish periods.

Average Directional Index (ADX) ✅

The average directional index is a momentum indicator used to measure the strength of a trend.

An ADX chart usually has three separate lines, the Negative Directional Indicator (-DI), the Positive Directional Indicator (+DI), and the average directional indicator, which is calculated using the other two lines. The ADX is used to determine whether one should go long or short on a trade or if any trade at all should be performed.

picture of the ADX chart
The ADX charts are useful for traders who want to see whether they should go long or short on a trade.

The top graph is the ADX where the green line is the +DI, the red line is the -DI and the black line is the average. The black line determines trend strength while the red and green lines determine the trend’s direction.

Whenever the ADX is over 25, that is taken as a strong trend. When it is below 20, that is taken as a weak trend. The crossovers of the -DI and +DI lines are used to generate trade signals.

If the +DI line crosses the -DI line and the ADx is 25 or greater, that is a good signal to buy. Conversely, when the -DI line rises above the +DI line and the ADX is 25 or greater, that is taken as a sell signal to enter a short trade.

Whenever the ADX line is below 20, that is a sign that there are no significant trends and that it might not be a good time to trade. Depending on how long of a time-frame you calculate over, the ADX can be more or less useful. In the short term, crossovers happen very frequently, almost too frequently to reliably take advantage of.

Bollinger Bands ✅

Bollinger bands are an extremely useful technical tool used to judge the volatility of a particular security. Bollinger bands are lines on a graph that are defined as 2 standard deviations away from a simple moving average. These two lines represent the region in which the price of a security generally hovers.

Picture of Bollinger Bands chart on Yahoo finance
With Bollinger bands, traders can superb info on the volatility of particular securities.

The shaded region of the graph represents the price range inside the Bollinger Bands. These particular bands were calculated using 2 standard deviations or the moving average, but these ranges are subject to investor preference.

Like the RSI, Bollinger bands can tell if some security is being overbought or oversold. The closer the average moves towards the upper band, the more overbought the security is. The closer if trends towards the lower line, the more oversold it is.

The closer together the two bands are, the less volatile the security is taken to be, whereas the further apart the two bands are the more volatile the security Is.

When the 2 bands get closer together, it is called a “squeeze.” A squeeze signal means that the security is currently less volatile, though squeezes are usually taken as an indicator of future price volatility. On the flip side, when the two bands get wider apart it is taken as a signal of future decreased volatility.

Keep in mind that Bollinger Bands alone are not meant to produce trading signals. A lot of people think that when the price goes above the top band that is a signal to buy and when it goes below the bottom band that is a signal to sell. This is not true. Bollinger Bands don’t really tell much about when the price will change or in which direction.

Bollinger Bands are most effective when used in conjunction with other momentum indicators such as RSI or ADX. These kinds of momentum indicators can tell you the direction of future price changes.

Tips on Using Technical Indicators 📑

First and foremost, you should never rely on just one technical indicator. On its own, an individual indicator does not really tell you that much. At the same time, using too many indicators can muddy the data and make it impossible to find reliable signals.

Paralysis by analysis” is a common stumbling block many new investors run into when they try to rely on too many technical indicators to guide their decisions. An overload of information makes it much more difficult to decide what to do.

The key is to find a decent mixture of technical indicators suited to your purposes. Technical indicators should always be used in conjunction with fundamental analysis and your own judgments about the price movement.

For example, if you are focusing more on long-term investments, then using a long time-frame moving average might be a good idea. In contrast, short term investors might use a trading plan involving an average directional index and Bollinger Bands to identify the strength and volatility of short-term market trends.

There is no one-size-fits-all approach here as every technical indicator has its strengths and limitations. The more experience you gain investing, the easier it will be to determine which technical indicators are the most useful for your purposes.

Conclusion

Such are the basics of reading a stock chart. Fortunately for you, several websites offer free interactive stock charts that come with all kinds of neat technical indicators built right in, so you can jump right in and start familiarizing yourself with stock charts. Some of our favorite stock chart sites include Google Finance, Yahoo Finance, and TradingView.

Keep in mind that the types of stock charts we covered are just the most common ones. There are several other stock chart types that are fit for different technical applications. Knowing your way around a stock chart is necessary to do any kind of technical analysis, so it’s recommended that you study up.

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