How To Read Stock Charts and Trading Patterns

Our journey through financial charts and their different categories in the previous chapter has laid the foundation for the visual interpretation of market data. The second phase involves preparing to understand and interpret these charts in detail and gathering meaningful insights that may aid investing or trading decisions. This chapter aims to empower you to read stock charts. So, let’s figure out what these lines and candles are trying to tell us.

Steps Involved in Reading a Stock Chart

Below are the major steps involved in interpreting stock charts:

Identifying Chart Type and Elements

By now, you already know about various chart types. We will now explore the essential elements that form these charts. A thorough focus on these elements will help to understand market behaviour and the underlying intricacies.

The fundamental terms associated with charts include Open, High, Low, and Close (OHLC). The OHLC values serve as the cornerstone for chart analysis and lay the foundation for understanding price dynamics, identifying trends, and making informed decisions. These terminologies, thus, form the language of price movements and encapsulate vital information about a stock's performance during a specific timeframe.

• Open (O): "Open" refers to the price of a stock at the beginning of a particular period, be it a day, week, or month. It's the starting point that sets the tone for subsequent market activity.
• High (H): "High" signifies the highest price reached by a stock during the chosen timeframe. It represents the peak value achieved, reflecting the maximum investor enthusiasm or demand.
• Low (L): "Low" denotes the lowest price touched by the stock within the selected time period. It marks the period that showcases the minimum investor interest or selling pressure.
• Close (C): "Close" is the price of the stock when the chosen period concludes. It showcases the sentiment and activity of the market at the very end of the timeframe and offers insights into potential trends.

Choosing the Right Time Frame

Moving on to the next step, we need to select timeframes that act as a lens through which we analyse price movements. Below are types of time frames that can be chosen based on investment objectives.

1. Daily Timeframe: Daily charts show price movements over a single trading day. They are ideal for short-term traders looking to capture intraday trends and make swift decisions based on daily market dynamics.
2. Weekly Timeframe: Weekly charts provide a broader perspective by condensing price data into weekly intervals. This timeframe is favoured by swing traders and investors aiming to grasp trends that unfold over several days to weeks.
3. Monthly Time Frame: Monthly charts offer an even more extended view, summarising price action on a monthly basis. Investors with a long-term horizon often turn to monthly charts to identify overarching trends and potential turning points.
4. Intraday Time Frames: For day traders operating in the Indian market, intraday time frames, such as 15-minute or hourly charts, are crucial. These charts capture price movements within a single trading day, aiding day traders in making quick and timely decisions.

Choosing the right time frame depends on your trading or investment objectives. Short-term traders seeking rapid movements may opt for intraday or daily charts, while long-term investors may find weekly or monthly charts more insightful. Changing timelines can often be done with simple dropdown menus or toolbar buttons, providing a quick way to zoom in or out of market activity and make more informed decisions.

Using Drawing on Charts

Drawing tools in trading platforms is essential for annotating charts, identifying trends, and performing technical analysis. These tools are accessible from the left panel of the chart interface. They enable traders to add notes, mark patterns, and calculate price levels effectively​​. Experimentation and practice with these tools allow the development of a deeper understanding of market behaviours. Below are some types of drawing tools:

• Trend Lines: Trend lines are important drawing tools that are fundamental for illustrating price movements and determining support and resistance levels. They include trend channels and pitchforks and are useful for visualising the direction of trends​​.
• Gann and Fibonacci Tools: These advanced tools help in locating key price retracements and sequences, with Fibonacci tools including retracements, extensions, and more, while Gann tools encompass box, square, and fan​​.
• Geometric Shapes and Annotations: These enable freehand drawing and adding text notes directly onto the chart for clearer analysis​​.
• Patterns and Forecasting Tools: Patterns and forecasting tools are useful for mapping out complex patterns like Elliott waves and making projections about future price movements​​.

Customising the style and settings of drawing tools tailors the analysis to individual preferences. Traders can adjust the visibility, colour, and thickness for clarity and save frequently used tools to a 'favourites' toolbar for swift access, enhancing the efficiency of chart analysis​​​​. 

Understanding the Trendlines

To interpret a stock chart effectively, it is essential to incorporate trendlines into the price pattern. Understanding trendlines allows investors and traders to gauge market sentiment and anticipate potential price movements. It forms the foundation for effective technical analysis and aids in making strategic decisions.

Imagine someone asking you today, "Is the stock market experiencing an uptrend, downtrend, or lateral consolidation?" Having a precise answer to this question holds significance for both the broader stock market and individual stocks. Why?

Opting for a long position (buying a stock) in an uptrend generally results in profit. 

But how do you determine the direction of the market?

Determining the market's direction, whether upward, downward, or lateral, can be done easily. Read below to know more:

• Uptrend: In an uptrend, the stock or market is moving upwards, forming either new highs or higher highs. This signifies a prevailing positive sentiment among investors, with buying pressure driving prices higher. To identify an uptrend, you must look for a series of ascending peaks and troughs. Higher highs and higher lows are indicative of an uptrend.
• Downtrend: In a downtrend, the stock or market moves downwards, creating either new or lower lows. This reflects a prevailing negative sentiment, with selling pressure pushing prices lower. A downtrend is characterised by a sequence of descending peaks and troughs. 
• Sideways Consolidation:In a sideways trend, the stock or market is neither making significant new highs nor new lows. Prices move within a horizontal range. This indicates a period of indecision or equilibrium between buyers and sellers. A sideways consolidation can be identified by a flat or horizontal price movement, with peaks and troughs occurring at similar levels.

So, How Do We Draw Trendlines?

A valid trendline requires at least two touchpoints. The more touchpoints, the stronger the trendline. Trendlines may need adjustment as new data emerges. You must ensure they align with the most recent significant price points.

Connect the highest points and the lowest lows with lines to identify an upward trend. If the price bounces off the lower line three times and continues upward, it's a positive sign. To spot a downtrend, draw lines through the decreasing peaks and valleys. If prices keep dropping after hitting the top line three times, it's a bad sign. To spot whether the trend is moving sideways, draw lines that stay even across the highs and lows, showing the market is in a holding pattern.

Wrapping Up

Learning how to read stock charts is quintessential for making smart investment decisions. By understanding different chart types, spotting patterns, and analysing trends, investors can better predict price movements. 

Now that you are well-versed in the basics of chart reading, we will read about advanced chart and trend analysis in the next chapter.