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The Basics of Stock Market Charts

By Edited Mar 19, 2014 0 2

Stock Market Charting for Beginners

There is a lot of money to be made investing in stocks and shares, unfortunately there is also a lot of money to be lost. If you are looking at the stock market and thinking this may be a good time to invest, after all we have just been through the biggest crash in stock market value since the crash of 1929, then you would be well-advised to arm yourself with some basic information before committing any of your hard-earned cash.

A little knowledge is a dangerous thing of course, but then so is entrusting your money to the 'experts'. Bear in mind that honest investment experts often make most of their money from the commissions they charge their clients for their expertise. Dishonest investment experts just make their money any way they can, and their clients are usually left holding the can. Check out the Bernie Madoff saga if you need any proof of that.

How to Choose which Stocks to Trade or Invest In ?

There are basically two methods people employ to help them decide which stocks to buy or sell (if we leave aside 'methods' such as sticking a pin into the newspaper) - fundamental analysis and technical analysis.

Fundamental Analysis and Technical Analysis

Fundamental analysis involves analyzing the fundamentals of a company, by studying its annual reports and other documents, such as newspaper articles. If you have a good understanding of company accounts then theoretically you should be able to read a company's annual reports and decide whether the share price is a good reflection of what the company is actually worth. If you consider that the share price is below what the company is worth then you may consider that you have discovered a bargain.

After all if you discover a painting by Rembrandt in a junk shop on sale for $25 then you may consider that you have found a bargain, but you do need to know how to distinguish a genuine Rembrandt from a forgery. The same applies to company accounts, if you really understand what you are doing then you can buy genuine bargains at cheap prices and wait for the stock market to catch up and for the share price to rise (this may take a long time so patience is often required). This is the method that Warren Buffett uses and he is after all the second richest man in the world (Bill Gates is first still at the moment) - so fundamental analysis if done correctly can be very rewarding. Warren Buffett also says that the stock market is a tool for transferring money from the impatient to the patient.

If you don't have the knowledge required to analyze company accounts and read between the lines then you will need to arm yourself with a knowledge of the alternative method - technical analysis.

Technical analysis has no interest in a company's fundamentals. The aim of technical analysis is to predict the future price of a stock by looking at previous prices and stock charts. Stock charts reflect price movements over time.

Stock charts show you what the stock price was yesterday or last week or last year and whether the trend is up, down, or sideways. Technical analysts claim that you can predict where stock prices will be at some point in the future based on the trend and a number of different signals that can be seen in the charts.

Some people claim that this is in fact mumbo jumbo and a total waste of time, but when all factors are considered it will be understood that charts are not in fact totally random. The way a stock price changes over time is the result of decisions taken by a large number of investors. The stock chart therefore is merely a representation in graphic form of human behavior.

Technical analysts also claim that stock charts show things that company accounts do not show and that they can in fact predict future events, for example if a business is about to go out of business it is highly likely that the stock chart will start trending downwards, as people on the inside get wind of what is going on and information starts to filter out to investors and stock market experts, despite the best efforts of the company to hide the fact.

There are always people who know what is happening to a company and they will trade the shares ahead of everyone else, this establishes a trend while everyone else is left wondering why the share price is falling or rising or no fundamental news.

The major advantage of technical analysis over fundamental analysis is that it is easy to learn, you do not need a degree in accounting. Charts are analyzed using a wide variety of technical indicators, the most common being 'moving averages'. A moving average is the average price of a share over a specific number of days, for example the 10 day moving average or the 20 day moving average.

Moving averages are important, because if a share price falls below a particular moving average this is generally interpreted as being negative and a sign that the stock price will continue to fall.

A particularly important moving average is the 200 day moving average, if a stock price moves below its 200 day moving average then this is generally recognized by professional investors as being negative and is taken to indicate that a long-term downward trend has begun. It is important therefore that beginners should understand this and know which signs to look for and more importantly which signs the professionals are looking for.

This 'crowd behavior' is important to understand. If everybody is rushing out of a football stadium it is usually not a good idea to try and go in the opposite direction, it would also be useful to know before anybody else that it was time to get out.

The beauty about stock charts and technical analysis is that far from being random they are in fact self-fulfilling prophecies. For example if a stock price drops below its 200 day moving average this is widely interpreted as being negative, therefore experienced professional investors will sell the stock when this happens, this selling causes the stock price to fall even further and thus investors can see that the charts were right. The charts in this case actually dictated behavior and the behavior proved that the charts were right. There are so many professional investors who follow these charts that as a small investor you have no choice but to either follow what they do or do it first, but in order to do that you need to know what they are going to do before they actually do it.

This was just a very basic introduction to the idea behind technical analysis and why it is important to understand at least the basics if you are interested in trading stocks online, with one specific example, the 200 day moving average, but if you are a beginner investor it is important to learn at least a minimum about charting to know the danger signals to look out for.



Aug 23, 2009 3:34pm
Trading heavily involves statistical analysis and you brought up some great points.
Sep 23, 2010 8:25am
Hi Dylan - thanks for the comment and the compliment - stock trading is not as easy as it looks and I think beginners are well-advised to take a look at the stock charts before taking the plunge
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