Stock Market Investing: How to Conduct a Chart Analysis
What is a stock chart?
A stock chart is the price of a stock over a set period of time. The y-axis (vertical axis) represents price scale and the x-axis (horizontal axis) represents the time.
Analysts use charts to analyze stocks and forecast future price movements.
Support and Resistance
Like everything in a free market, stock prices are driven by supply and demand. When supply outpaces demand, the price goes down and when demand exceeds supply the price goes up. When supply and demand are equal, prices move sideways.
As a stock price declines towards support levels and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.
The same holds true for resistance levels. As prices increase toward resistance levels, buyers are less likely to buy and sellers are more likely to sell and the price is prevented from going above the resistance level.
Above is a chart for IBM stock. Drawn on the chart are support levels and resistance levels. As you can see, for several months IBM bounced around support levels of around $143 and hit resistance levels around $150.
Support and resistance levels do not always hold. Events may cause changes in thinking in buyers and sellers and cause stocks to bust through support levels and break out through resistance levels. Once this happens, new support and resistance levels need to be established.
The chart above shows how Wells Fargo stock bounced around its support and resistance levels for most of 2016 and 2017 before breaking out and establishing new support and resistance levels.
Identification of key support and resistance levels is an essential ingredient to successful stock analysis. If a stock is approaching a support level it can serve as a indication that there will be increased buying pressure and that the price may reverse. The same holds with stocks approaching resistance levels. As a stock approaches these levels an investor should be on the lookout for increased selling pressure and a potential stagnation or decrease in price.
A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance
An Uptrend Line is formed by connecting 3 or more low points where each succeeding low point is higher than the previous one. Uptrend lines indicate that demand is increasing even as the price rises.
A rising price combined with increasing demand is very bullish, and shows a strong determination on the part of the buyers. As long as prices remain above the trend line, the uptrend is considered solid and intact
The chart above for Amazon shows a very well established upward trend line.
Downward trendlines have a negative slope and are formed by connecting three or more high points. They indicate that supply is increasing even as the price declines. A declining price combined with increasing supply is very bearish, and shows the strong resolve of the sellers.
The chart above shows a confirmed downward trend line for GE stock during the early part of 2018. The stock experienced sharp and steady decline due to a variety of factors.
Trend lines can offer great insight into the enthusiasm of either the buyers or sellers of a stock. They are good tool to use with support and resistance analysis to determine how to make stock investing decisions.
Chart analysis is a good tool for making stock investment decisions.
By determining support and resistance levels, one can make more accurate decisions regarding buy and sell points. One should consider buying at support levels and selling at resistance levels.
Trend lines can be used to determine enthusiasm for stocks. A confirmed upward trend line indicates bullish sentiment for a stock while a confirmed downward trend line indicates bearish sentiment.
These principles should not be the final arbiter, but should serve merely as a tools to combine with other information such as financial data to make decisions. A good chart analysis is however, part of any thorough analysis of a stock and should be conducted before any buy or sell decisions are made.