One of the most important skills to develop as an investor is the ability to read stock charts. Why? Because the stock chart is the single most important and often the only tool you need to make your investment decisions.
Stock charts represent the price movement of a single security, but they can also be used to show the health of an index or industry. Charts for major indices like the DOW, NASDAQ, and S&P 500 tell you how the overall stock market is doing. The charts for things like the price of oil or gold tell you about the market for a specific commodity or industry. Being able to read a stock chart will do more than help you build your own investment portfolio, it will help you better understand the global stock market and world economy.
What is a stock chart?
A stock chart is a graphical representation of the price and other financial data of an asset or market over time. This is the most important tool investors rely on to be able to see patterns and trends of their securities.
Stock charts are considered to be “efficient”, which means they contain all the available information about a specific security as well as reflect current market conditions and events. That makes it easy for you to not only get relevant information about the financial health of the company the chart represents, but also information about the economy and even investor sentiment.
Why is this information crucial for investors? We all know sometimes great companies see their stocks hammered for no reason, or because of an event outside their control. For example, when the global pandemic began in March 2020, nearly every stock tumbled by approximately 30%. This fall in price is reflected in every stock chart, but represents external factors not what was necessarily happening within each business.
Stock charts are one of the most important tools to use to make investing decisions, containing all the information you need to determine whether you should buy or sell. For short-term and day-traders, stock charts are often the only tool they use to inform their trades.
Even if you’re not looking to make a trade, a stock chart can quickly tell you how an investment is performing or how the overall market is doing. As an informed investor, reading stock charts will likely become part of your daily routine, and something you do at least once if not multiple times throughout the day to keep up with current events.
Why is it important to know how to read stock charts?
Reading a stock chart is the fastest and easiest way to get months or years of financial data about an investment in a matter of seconds. You can look at a stock chart and get an instant idea of how an asset is performing and what the short and long-term trends are. This simple chart also provides the basis to do technical analysis, which lets you use patterns in price movement to predict where the stock will go next.
In short, you can’t call yourself a stock market investor if you don’t know how to read a stock chart.
What makes up a stock chart?
A stock chart conveys a TON of information in a very small picture. This is why they’re so valuable! But to the uninitiated eye, all those numbers, squiggles and investment jargon might as well be a foreign language.
You first have to understand what components that make up a stock chart and then use your judgment and preferences to determine whether a stock is right for you: the axes, which display time and price, will be consistent across all charts, but how the price is plotted as well as any additional drawings or analyses come down to investor preference. Here’s what you need to know.
Stock chart components
A stock chart is made up of three main parts:
- The x-axis, representing a period of time
- The y-axis, representing a scale of price
- The plotted price of an asset. This is usually shown as a line, but can be shown in other forms such as candlestick or bar.
And there’s one more component that isn’t always displayed but might be useful for potential investors:
“Charting tools” or “Drawings” that provide additional information including trading volume (the quantity that a particular stock is being bought or sold over time), RSI (Relative Strength Index—or, a graph that shows you how quickly and frequently a stock is being bought or sold), and other mathematical patterns in price movement. These are not typically visible on your basic stock chart, but your brokerage or stock news website will offer to display them using a drop down menu.
Stock chart terms to know
Here are the key terms to help you understand stock charts:
Axis – the reference line used to measure plotted points on a graph. In a stock chart, the horizontal axis always displays a period of time and the vertical axis displays price.
Price – the stock price is plotted on a stock chart as either a line, bar graph, or candlestick chart. When you people say “stock chart”, what they are really referring to is the price of an asset plotted over time.
Interval – the interval refers to the length of time over which the price points are plotted. If you’re looking at a 6-month or 1-year stock chart, you’re probably viewing a daily interval of stock price plotted over time.
Line chart – the most common graphical display of a security price over time, and what most people picture when you say “stock chart”. The line graph displays the closing price over the interval you have selected. As an example, here is Tesla’s stock chart displayed as a line graph:
Candlestick chart – a popular way to view a stock chart, especially for more active traders. A candlestick chart displays not only the closing price of a security over your chosen interval, but also the opening price, and the trading range in that period. Here is Tesla’s candlestick chart:
Bar chart – a bar chart is a less frequently used stock chart, but similar to a candlestick chart. It also displays the opening and closing price of a security, as well as its price range in your selected interval. Here is Tesla’s bar chart:
Volume – trading volume is a bar graph typically displayed along the bottom of a stock chart. It shows how many shares of a security were traded during the time interval you’ve selected. Here is Tesla’s trading volume displayed below its 6-month chart:
How do you read the stock market chart?
Now that you know how a stock chart is displayed and what those graphs actually mean, here’s how to put this info to use.
Step 1: Choose your timeframe
The first thing you should do when reading a stock chart is to choose the timeframe you want to look at. If you’re using a major stock news website like Yahoo! Finance or MarketWatch, they will likely default to a daily stock chart. I personally like to use 1-month or 6-month stock charts to get a clearer understanding and more context on how an asset is performing.
Here is Tesla’s 6-month stock chart:
See how you can toggle between different timeframes at the top of the chart? You might want to look at two or three different time periods. That way, you can get both a wider and more general, as well as a narrower, more detailed, sense of how a security is charting. Take a quick glance at the 1-month, 6-month and 2-year charts of any investment you’re considering adding to your portfolio.
Step 2: Choose your display
Next, make sure the stock chart is displayed in the format you prefer. Because I typically make long-term trades, I use a line chart, but more active traders might prefer a bar or candlestick chart.
Depending on what platform you’re using, your stock chart will also include little bars indicating trading volume along the bottom axis of the chart. While these don’t provide information about price, they do tell you how actively the stocks are being traded.
Tall volume bars indicate lots of buying and selling activity, whereas shorter ones indicate fewer trades. Stocks with high trading volume tend to be more volatile in price and are favoured by short-term traders hoping to turn a profit quickly.
Here’s is Tesla’s 6-month candle chart:
You can see the chart displays the same trend as the line chart, but has a little bit more detail. This is because bar and candlestick charts show the high and low values for each price point, whereas line graphs only show the closing prices.
If you’re not sure whether to choose a candlestick, bar, or line chart, remember more information isn’t necessarily better! Many people think candlestick charts are more useful because they convey more data, but much of the information they display is irrelevant to most investors. Unless you’re an active trader, you probably don’t need to know the price movement in the detail displayed in a bar or candlestick chart. For many investors, whether the price is tracking up or is it tending to go down over time is often enough to make a decision about whether or not they want to invest—assuming they’ve also done their research into the company, as well.
Step 3: Read from left to right
At this point, you’re going to want to take a quick glance over the stock chart to determine if you want to delve into more detail. The displayed price information moves from left to right.
Step 4: Draw directly on the chart and/or overlay additional analyses
Most major market sites will provide a variety of technical analysis tools to help investors make their short-term trading decisions. In my Finance MBA, we were taught how to do these calculations by hand, but thankfully most brokerage software lets you select options from a drop-down menu that get automatically overlaid over top of the stock chart graph.
Some of my favourite technical analysis tools are moving averages, Bollinger Bands (which helps to determine whether a price is high or low relative to its moving average), and RSI. But often I will simply draw my own lines directly on a chart. These drawings help you readily identify buying and selling opportunities based on a security’s price movement. Technical analysis tools help you optimize your trading activity in order to maximize profit.
Here is Tesla’s 6-month stock chart with overlay graphs of moving averages and Bollinger Bands.
You can see that the stock price has fallen to the bottom of the lower Bollinger band, which typically indicates it’s likely to turn around and go back up. Likewise, the stock is trading below its 50-day moving average, which means it’s relatively cheap compared to its price over the past one and half months. If I was using only BBands and the 50-day moving average to time my trades, this would indicate now might be a good time to buy Tesla stock.
Whether you’re drawing simple trend lines or doing a more complex Fibonacci retracement, these technical analysis tools will help you get even more out of your stock chart. While these charting tools are good at predicting price movements, they are never a guarantee. Even with the best drawings, it’s possible for a stock to perform differently than expected!
Step 5: Identify trends and events
Once you’ve familiarized yourself with the graphs and trend lines of a stock chart and have added any technical analysis drawings, it’s time to dig into the data.
Look for anything that stands out: sharp increases or decreases in price, high trading volume, and so on. Sometimes these can be explained by global market events or things that have impacted the company like a new product announcement or bad press because of a CEO scandal.
Remember, stock charts are efficient! All the available information about a security is reflected in its price. But also remember that stock charts can only show the past, not the future. There’s no way of knowing for sure what a stock will do next—however, looking for patterns and trends can at least help you make an informed guess as to how a security might respond to certain events in the future.
The last word
Once you’ve mastered the stock chart, you have the skills to invest in the stock market. If you’re a long term trader, reading a stock chart is part of checking in on your existing investments and evaluating new ones to add to your portfolio. If you’re a short-term trader, the stock chart is how you make virtually all your investing decisions. If you’re ready to take the plunge into the stock market, check out How to Start Investing Online in Canada and put your new chart reading skills to good use!