The basics of the stock chart
Stock charts are a historical presentation of the price of a stock, and where it has traded at a given time in the past. The below image shows what is shown on any basic stock chart – the recent history of price and volume, i.e. at what price levels shares have been bought and sold, and how much of it.
Here is a simplified chart that shows how charts portray price (i.e. where traders have bought and sold stock) and volume (i.e. how much of that buying and selling has occurred) at a given price level.
The main function of charts is that they alert a speculator to “something unusual” occurring, which almost always means starting or ending institutional interest in a stock.
For the moment, don’t think about the lines/bars/colors in the charts too much, we’ll learn how to read those later in much more detail.
Don’t hope, don’t anticipate
The first factor that we’re looking for, on the chart, is price, or rather, change in price. We want to make profits, money, and you make money when the price of the stock you own goes up. You don’t make money when the company reports good financials, has a great product, or your friend works there – you make money when the stock price trends up meaningfully. Going back to what we learned, we are here looking for a trend – an up-trend in price, caused by heavy institutional buying demand.
You don’t want to buy a stock in the anticipation that institutional money might drive it’s price up at some point in the future, or on the hope that it might be discovered at some point, because that may never happen – and often never does.
Worse, a stock that trends sideways or down that you hope might be driven up by institutional money in the future could on the one hand drop even more and more, causing you large losses if you don’t manage risk, or on the other hand could move up much much later only, bringing high opportunity cost of having had your money locked up all the time in between. The truth is, no one knows what will happen in the future in the stock market. Nobody, no mathematician, not the president of the stock exchange, not a company’s CEO, and not the most eminent economist and profitable speculator.
Thus, you don’t want to buy something that you hope might go up in the future, and keep your money sitting in it unproductively during a strong bull market while watching in disbelief how other stocks start making good money for their holders.
The chart below shows a stock going sideways, and really nowhere … buying on hope would not made you have money. A speculator in stocks does not care about a stock that goes sideways without conviction, because it shows lack of aggressive institutional buying and established trend that is likely to continue.
Institutional money can’t hide their hand
In here lies the beauty of public equity – institutions taking positions cannot hide their hand. Because of their sheer size, their buying and selling causes clear signs in the price and volume activity that is plotted on a stock chart, and can be clearly distinguished from amateur activity, with a bit of skill that you will acquire of this course. As an individual speculator you can literally piggyback these institutional investors buying up a stock as a group. You’ll only have to do a minimal amount of research – if any at all – as you can see whether the big boys with the best research in the world at their fingertips are interested in something quickly.
Seek evidence of institutional buying already happening
The only way to be certain that institutional buying will drive up a stock is when you can already observe that very fact on the chart, when this possibility has already manifested in reality, when it has just started to happen. You want to join a move where you have not just an expectation, but a confirmation that there is institutional interest in a stock via a strong price trend already being underway, serving you on a plate the reality that you don’t have to hope but know that you actually can make money in this stock.
So, you do not want to speculate on your opinion of what should happen, or what you think some institutions might do at some point. You will lose a lot of money this way – not necessarily in all in actual losses but also in missed profits. Rather, you want to speculate on the likely continuation of a trend that is already happening. I repeat for emphasis – we speculate on a trend that is already happening, at a time where it is most likely to continue. As an anecdote, I know a few speculators that aren’t even interested in buying a stock until it has at least doubled in price in the last year or so, to see that there is a strong trend first.
The way to spot trends is chart reading. The terms ‘chart reading’, ‘technical analysis’, and ‘price volume analysis’ are used interchangeably, and they all refer to the exact same thing. I most often use the term price-volume analysis, abbreviated “PVA”.
The chart below displays a stock that shows a starting trend caused by institutional buying, which then continues to move up over 300% – a trend a stock speculator can then latch after awaiting a reasonable time point to enter the stock. A speculator is not interested in a stock until it shows signs of strength, i.e. until institutional buying establishes the start of a trend that is likely to continue. Remember that we will frequent stocks that will attract a lot of institutional buying which is stretched out over long time frames, thereby causing trends to stretch out over time.
Charts reflect past and current human actions, decisions and psychology
Now, why are charts, or price-volume analysis, so important? Remember that the only thing that people can do in the market are buying, selling, or holding varying amounts of shares. For large moves and trends to form, the only thing that matters is the ratio of supply and demand, which is based on people’s buying, selling or holding – and overwhelmingly that of institutional buyers and sellers, for that matter. Since everybody that acts in the markets has to act through an exchange or an equivalent body that records amounts of shares bought/sold, all this information is collated centrally and can be visualized for quick overview – in the form of stock charts.
The lines and bars on a chart summarize the decisions, strategies, beliefs, impulses, hopes and fears of hundreds of millions of actors placing orders in the market or waiting for their time to act. That includes the “smarter” speculators and institutional managers that understand how the market works, and the “dumb” money, which are the unwitty amateurish speculators and less-witty institutional managers, including the notorious “retail investor”.
Chart reading gives us insight into what people are doing and how much of it, over time, which sums up to a picture of supply and demand. Charts are thus a printout of the psychology of all market participants, lending someone adept in chart reading deep insights into the actions of the crowd as a group.
Charts visualize crowd psychology
This crowd psychology predicates a couple of interesting effects that we will discuss into more detail later. One of them is that if an up-trend is in motion, it will likely continue to do so, because every time the price drops, some group of people earlier saw the up-trend and decided they were going to buy it the moment it became cheaper, including speculators that missed out, institutional owners selling into rallies for profit and buying back at pullbacks to give the stock support and mark the price up in the long-term, wrongful short sellers that need to cover their position (i.e. buy stock), and many more.
Because trends stay in motion longer than many people think, a stock speculator waits until a trend has established itself (to show the actual presence of institutional buying and support), and then latches onto it to use the high probability of the trend continuing to make money. There is an old saying, “The trend is your friend”, a.k.a. “Don’t fight the trend” – I like very few Wall Street sayings, but this is a rare gem that is 100% true. Changes in stock prices make money, and trends are nothing more than a consistent series of price changes that is more likely to carry on than to reverse at a given time. An absence of a trend, i.e. an absence in the consistent change of price, makes you no money. Don’t ever fight trends either, because changes in stock prices in the other direction don’t make money – they lose it.
When I wrote above that a speculator “latches on to a trend”, I don’t mean to say that a speculator just buys a stock that he likes at any time he feels like it. He has to patiently await a very specific time window, called a ‘low-risk entry point’, where the odds of him immediately making money and the trend going his way are the highest. Bear with me, we’ll discuss that later in much greater detail.