How to Read Stock Charts

A stock chart is simply a pictorial view of the price of a stock over time. Virtually all common styles of stock charts can be generated free online or through your online stock brokers. Just generating charts is not enough though. You need to learn how to read stock charts in order to gain any value from them. Learning how to read stock charts can be broken down into understanding the timescales, understanding the price scales, and knowing the different charting styles.

The Time Scales

The time scale you choose determines how often the price movement of the stock is summarized. If you were to look at the stock price every second the chart would look like it was buzzing.

In order to see price data that is relevant to the investment you are looking to make you should set the time frame to be similar to the amount of time you intend to hold the stock. If you intend on holding the stock for decades set the time frame to yearly. If you intend to hold the stock for a week then follow the weekly or daily data. Always look at the longer time frames after you find a stock that interests you because you may find a longer term trend that is clearly in opposition to your trade plans. It doesn’t mean your trade isn’t correct if a longer term trend is countering it, it just lowers the odds a little bit that your trade will go as planned.

If you are buying penny stocks, you need to determine if you’re looking to capitalize on day trading or if you’re just looking for a diamond in the rough to stick with for the long run.

The Price Scales

The hardest part for me to grasp when I was learning how to read stock charts is why anyone would choose to set their price scale to logarithmic versus arithmetic. The arithmetic scale is the traditional way you would assume the prices would be set on your chart. Essentially all the prices are evenly spaced. So when the price moves from $5 per share to $10 per share it looks the same in distance when the price moves from $20 per share to $25 per share. This is how we are used to thinking about money. You’ll need to learn to think a little differently if you are seeking real penny stock fortunes.

When it comes to earning money from stock investments you need think about gains and losses in percent changes. If you buy a stock for $10 per share and it gets to $15 per share you earned $5 per share. You would also earn $5 per share if your $20 stock went to $25 per share. The arithmetic price scale would show this price gain evenly. However, both stock investments did not return equally. The stock you bought for $10 per share gave you a return of 50%. The stocks you bought from $20 per share only returned 25% of the money invested. The first investment performed much better. In order to magnify the difference of these two investments you need to plot the price movements on a logarithmic scale. The logarithmic scale (sometimes call semi-logarithmic scale on charting systems because they live the date (time scale) arithmetic) prices percent changes on equal distances. So now the $10 investment move would look twice as large as the $20 investment move.



The second advantage to the log scale price plotting is that you can quickly determine the average return per year of a stock. Stocks are known to be a compounding investment. When someone says the price returns 10% per year that means a $100 stock would return $10 the first year, then the next year it would return $11, and then next year it would return $12.10. Comparing two stocks can be difficult because the price movement years ago looks really small compared to the big growth in the present time. When you convert to a log scale the price movements will often look more like straight lines climbing up. Whichever stock has a “steeper” straight line has been doing better.

Charting Styles

The four major types of charting styles you’ll use when research penny stocks online are the point chart, the bar chart, the candlestick chart, and the point and figure chart (pf chart).

The Point Chart

The point chart is simply the closing price at the end of every time period in the timescale you selected marked on the chart with a dot. Sometimes the dots are left off the chart and just the line connecting the dots is shown. Useful for quick checks on stocks to just see “how they are doing” or when you don’t use much technical analysis in your buying decisions.

The Bar Chart

The bar chart is the point chart with some added information. The open and close of the stock market time frame is shown with a horizontal line into the line. The line tops out at the high of the period and the price line bottoms out at the low of the period.

The Candlestick Chart

When teaching people how to read stock charts for penny stock trading I really enjoy the candlestick chart. The candlesticks are formed just like a bar chart except the open and close prices form a box. The box is left white if the price increased over the time frame and the box is filled black or red if the price decreases. The band of white and black boxes is called the body. The tails of period high and lows is called the shadow. The candlesticks give a great visual of the time frame with a clear reference of where support and resistance levels are formed by the body and where the shadows tried to penetrate, but failed.

The Point Figure (PF) Chart

The point figure chart attempts to summarize chart data by only showing significant price moves. The pf chart was started before the invention / popularity of computers when brokers or traders would maintain data on graph paper. In order to minimize the size of the charts and reduce tracking only price changes that exceeded a quantity deemed significant by the trader would be recorded. Also, the charts don’t move horizontally with every new period, but only when the price direction reverses. So if the price is moving up there is a vertical series of “X”s and if there is a fall in prices there is a vertical series of “Os.’ The chart only moves right when the direction of the stock prices changes. With this charting support and resistance levels are very easy to see because they are not spread out over “flat” price times.

You should now have a good overview on how to read stock charts and stock charting software. Your next step should be reading about the different patterns in the charts and finding support and resistance levels so you can glean more information from these stock charts.