Knowing How to Read Charts Gives You an Edge in Stock Trading

Markets are moved by human emotion: fear, greed, doubt, and hope. Since human nature never changes, the participants' collective behavior in the market repeats itself, even though the participants themselves change over time. Charts are a graphic representation of the participants' collective actions in the market. The predictive value of charting is in applying past patterns to current situations on the premise that they are likely to repeat themselves.

The biggest misconception about technical analysis is that a chartist can look at a chart at any given point in time and tell what a stock is going to do next. Not so. Stocks spend most of the time forming patterns. It's only when a pattern is completed that a chartist can tell with some degree of certainty what is likely to happen next.

Charting is not foolproof (well, neither is trading...). It is based on assessing probabilities. So by looking at a chart, a trader can tell what is and is not likely to happen next.

Markets are rife with manipulation. A lot of investment information that is being disseminated is actually opinion, not fact, and is either of limited value or skillfully designed to induce a particular action. Usually, it's to force the investor to part with his money. By looking at a chart, the investor can quickly assess the validity of a proffered opinion and decide whether the suggested action is warranted.

In trading, there is a big difference between what people say and what they do. Talk is cheap. Only what they do counts. Charts help separate action from words.

Some liken charts to cheating. You can spend hours and even days poring over balance sheets, ratios, earnings models, and industry and market data to assess a stock's prospects. But since the resulting action of all participants is reflected in a chart, one look at a chart can replace days of fundamental analysis. After all, when all is said and done, a stock has only two ways to go - up or down.

There are some traders that just trade off a chart, without looking at anything else, claiming that a chart tells them everything they need to know. Others combine charting with fundamental analysis on the premise that fundamental analysis tells you what to buy, while charts tell you when to buy it. And in stock trading, when to buy is as important as what to buy.

There are several excellent books on charting. Robert Edwards and John Magee's "Technical Analysis of Stock Trends" is an undisputed classic. There are also numerous online courses that teach basic charting. The thing to remember is:

- Different chart patterns prevail under different market conditions;

- There are several different charting methods and more than one way to interpret stock wiggles.

- Only so much can be described and catalogued in the books. The rest comes from experience.

What matters in the end is that you find profitable patterns that repeatedly work for you. Who cares what you call them?