Investing in the stock market isn’t just about following the news or looking at quarterly earnings reports. A significant part of understanding market movements and making more informed trading decisions involves reading and interpreting stock charts.
Stock chart patterns offer a visual representation of market psychology, capturing the interplay between buyers and sellers. Learning how to read these patterns may help you anticipate potential price movements and identify trends before they fully unfold.
In this article, we’ll explore the basics of stock charts, the most common types of chart patterns, and how to use them to guide your investment decisions.
What are stock chart patterns?
Stock chart patterns are graphical representations of stock price movements over a specific period. These patterns emerge from the interaction of buyers and sellers and may signal potential trends or reversals. They are commonly categorized into three types:
- Continuation patterns: Indicate that the current trend will likely continue.
- Reversal patterns: Signal a potential change in the current trend.
- Neutral patterns: Provide no clear direction but suggest a breakout is imminent.
Types of stock charts
Before diving into patterns, it’s important to understand the different types of stock charts used to analyze price movements. Each chart type offers unique insights, and the choice of chart often depends on your trading style.
1. Bar charts:
Display price movements throughout the day, including the opening, high, low, and closing prices. Vertical bars represent the range of prices, while small horizontal lines indicate opening (left) and closing (right) prices. Color coding often shows whether the closing price is higher or lower than the opening price.
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2. Line charts:
Connect closing prices over a chosen timeframe, simplifying the picture by omitting intraday price fluctuations. Line charts help beginners focus on overall trends without the noise of intraday movements.
3. Candlestick charts:
Show the open, close, high, and low prices for a given period. The candlesticks are color-coded to reflect price movement (e.g., green or white for up, red or black for down) and may often reveal investor sentiment patterns.
Point-and-figure charts filter out minor price movements and focus on significant changes. They may remove the noise of day-to-day fluctuations, which can allow you to see long-term trends more clearly.
5. Heikin-ashi charts
A variation of candlestick charts that smooths out price data, offering a simplified view to highlight trends and reduce market noise. It may help to highlight trends and reduce short-term market fluctuations.
Common stock chart terms to know
When learning how to read stock market charts, look for the following terms:
- Ticker symbol A unique series of letters used to identify a company’s stock. For example, Disney trades under DIS on the NYSE.
- Opening price The stock’s price at the start of the trading day (9:30 am EST on weekdays, excluding holidays).
- Closing price The final trading price when the market closes at 4:00 pm EST. If it’s higher than the previous day’s close, that suggests an upward trend; if lower, a downward trend.
- Previous close The stocks final price from the previous trading day.
- The day high and low the highest and lowest prices the stock traded at from the opening of the market to the close of the market on that day other than the opening and closing prices.
- Day high and low: The highest and lowest prices during the current trading session.
- 52-Week high and low: The highest and lowest closing prices over the past 52 weeks.
- P/E ratio (Price-to-earnings ratio): Current stock price divided by the company’s earnings per share over the past year.
- Trading volume: The number of shares traded during a specific period.
- Dividends per share: Profits distributed to shareholders. Not all companies pay dividends.
- Dividend yield: The annual dividend amount divided by the current stock price, shown as a percentage.
- Market cap: The companys total value, calculated by multiplying the current share price by the number of outstanding shares.
- Trend line: A line that connects two or more price points and extends into the future, acting as support (lower boundary) or resistance (upper boundary).
Common stock chart patterns
Lets look at some of the most common stock chart patterns:
1. Head and shoulders
This is often viewed as a reversal pattern. It consists of three peaks: the middle peak (the head) is the highest, flanked by two lower peaks (the shoulders).
- How to Identify:
- Look for a left shoulder, a higher peak (head), and a right shoulder.
- A neckline connects the lows of the two shoulders.
- Implication:
- A break below the neckline may suggest a bearish reversal.
- If inverted, it might signal a bullish reversal.
2. Cup and handle
This is often viewed as a continuation pattern that resembles a tea cup with a handle.
- How to identify:
- The cup is a rounded bottom, indicating consolidation.
- The handle is a short pullback before the price potentially breaks out.
- Implication:
- A breakout above the handle could suggest an upward movement.
3. Double top and double bottom
These are classic patterns that suggest potential reversals.
- Double Top:
- Two peaks at a similar price level, signaling resistance.
- A break below the neckline may confirm a bearish reversal.
- Double Bottom:
- Two troughs at a similar price level, signaling support.
- A breakout above the neckline may confirm a bullish reversal.
4. Triangles (Ascending, descending, and symmetrical)
Triangles represent periods of consolidation before a breakout. They can be continuation patterns but might also signal reversals depending on the breakout direction.
- Ascending triangle:
- Horizontal resistance with higher lows.
- A breakout above resistance could suggest a bullish trend.
- Descending triangle:
- Horizontal support with lower highs.
- A breakout below support might suggest a bearish trend.
- Symmetrical triangle:
- Converging trendlines with no clear bias.
- Breakout direction determines the trend.
5. Flags and pennants
Flags and pennants are short-term continuation patterns that occur after a strong price move.
- How to identify:
- A flag appears as a small rectangle sloping against the prevailing trend.
- A pennant looks like a small symmetrical triangle.
- Implication:
- A breakout in the direction of the preceding trend may often confirm the pattern.
Bottom line
By understanding stock chart patterns, you can add another layer of insight to your trading strategy. While patterns may not provide guarantees, they can serve as a useful tool in analyzing market movements and making well-considered decisions.
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Frequently asked questions
How can I start investing in stocks?
To start investing, you’ll need a brokerage account, but they are simple to set up. Check out the Public app to get started.
Do trends continue over long periods of time?
Stocks may stay put for a while, but eventually, the trend will change to an uptrend, downtrend, or show some type of corrective action.
Can there be signs of a trend reversal?
Some signs to look for are momentum indicators that show a stock slowing before it reaches its peak, which can indicate it may be getting ready for a trend reversal. In addition, various chart patterns can make it easier to watch and identify changes in the stock. Although, to be clear, none can predict or guarantee what will actually happen.
Do stock trends change in a similar way?
When it comes to trends, some stocks move at a slow pace while others move more quickly and experience more volatile movements with sudden changes and reversals.
Are there chart patterns that work all the time?
Investing is an ever-changing environment, and there are no guarantees of anything working 100% of the time (or 50% of the time or at all), including chart patterns. Getting the best results takes practice and finding what works for you. But it’s always a gamble.
How can you tell if a stock will rise or fall?
We know that bullish patterns are expected to move up while bearish patterns are expected to move down, but the stock market is a volatile place, and we never really know what’s going to happen.
