As I learned how to trade stock options, it was hard for me to find a good lesson on charting stocks. I kind of just figured it out on my own. Since options are derived or come from stocks, it’s essential to know how the price of the stock is behaving as this will greatly affect your option’s value.
It’s no different than doing science experiments in school. You collect data (stock prices) and then that data is plotted so you can see the overall big picture of what is going on. There are also several tools (technical indicators) that you can use to help you read stock charts, however they are beyond the scope of this lesson.
Technical analysis is the formal name for analyzing and charting stocks. There are some traders who are pure technical analysis traders. They use the chart and nothing else. According to technical analysts, the chart can yield important clues to how a stock will perform in the future.
Charting stocks can protect you from big losses and help you further your option trading gains.
In order to fully take advantage of what the chart is telling you, you must first understand the basics of reading stock charts.
A stock chart is simply a graphical representation of the stocks price over a set period of time. The chart shows you at a glance how a stock has performed.
There are three 3 basic types of stock charts (bar, line, and candlestick) and depending on your trading style, each chart will serve its own unique purpose. Regardless of what type of stock chart you use, all three do nothing more than reveal the buying and selling patterns of the investors. This is something that is hard to discern by reading stock quotes in the daily newspaper.
That is why charting stocks has become so invaluable.
My wife thinks a stock chart looks like a hospital heart rate monitor. I too wondered what all those squiggly lines and numbers meant when I first started charting stocks.
4 Key Areas of Every Stock Chart
There are 4 key areas you want to become familiar with when charting stocks:
Identification Section
Time Frame
Volume Bars
“X” and “Y” axis
Let’s pull up a stock chart and go over these key areas. For our example we will be using the chart of Potash Corporation. To follow along go to Marketwatch.com and in the top right corner type in the symbol “POT”.
Identification Section
Company Name: Potash Corporation
Trading Symbol: POT
Stock Exchange Where Traded: New York Stock Exchange “NYSE”
Current Date: (top right corner)
Days Price Change: opening price, days price high, days price low, and closing price
Volume: how many shares of the stock were traded for the particular time period
Change: this is the day’s dollar change compared to yesterday’s closing price. The dollar change and the percent change will be listed.
Time Frame: the chart will display what time frame you are viewing (1 year, 6 months, etc.). It is highly recommended to change the time frame to one that suits your trading style. Looking at a 3-6 month chart is necessary if you have a short term investing plan, and 1-5 years if you have a long term investing plan.
Volume Bars: volume is often called the heart of the stock market. It’s a key indicator of supply and demand. By looking at the volume bars you can get a good feel for the strength behind the stock price movement. A stock moving higher on heavy volume is much more likely to continue climbing than one that is moving higher on light volume.
“X” and “Y” axis: the “X” axis is the bottom portion of the graph, running horizontally, and it flows left to right. It’s the portion of the graph that has the time frame that you are looking at. The left side is the past and the right is the present. We use the past as a reference, but we trade from the right side of the chart. We trade what we see now.
The “Y” axis is the right side of the chart, running vertically, and flows top to bottom. This portion of the graph has the price action.
Essentially for the beginner, charting stocks boils down to three things:
You’re going to look at the correlation between a stock’s price and volume activity (as shown by the price and volume bars).
You’re going to look at the chart and determine if the stock’s price has been trending up or down. If it’s been trending up, I buy call options. If it’s been trending down, I buy put options.
You’re going to determine where the stock’s support and resistance levels are. Support and resistance are areas where the stock has had trouble proceeding past, or an area where the stock halts and changes direction.
As you flip through your stock charts, you’ll start to see stocks that look interesting. Jot them down and these will be the stocks you’ll eventually use to build your daily watch list. You’ll then apply other tools (technical indicators) to the chart to further pinpoint trading opportunities.
A stock chart can provide you with a wealth of knowledge as long as you know and understand what you’re looking at. Basic charting knowledge combined with other stock indicators can immensely improve your trading skills.
Charting stocks has helped me find several profitable option trading opportunities, and it’s a skill that becomes easier over time. So if you’re going to be an options trader then learning how to read stock charts is a must.