Stock Charts: How to Read Them

We now know the various kinds of charts used for technical analysis of stocks: candlestick, bar, line, and point and figure charts. We’ll go over these charts in more detail in this part, as well as the many patterns that may be utilised to decipher stock charts.

Requirements for interpretation

The goal of technical analysis is to understand the movement of stock prices and transaction volumes. There is a lot of information out there regarding them. It must, however, be transformed into a format that can be readily understood and traded.

The development of stock price charts is the first step in technical analysis. Following that, you must understand these graphs. For this, you may utilise tools like as momentum indicators, chart patterns, and trend lines. These tools have already been discussed in earlier sections.

We’ll look at some of the chart patterns that are utilised to analyse these graphs in this section.

Stock Charts: An Introduction

After learning how to make technical charts, the next natural step is to learn how to read stock charts. We’ll go over some basic stock chart patterns that may be utilised for stock chart analysis and deriving crucial conclusions in this part. Reversal patterns and continuation patterns are the two types of chart patterns. Except for point and figure charts, these designs may be used for any form of chart.

Pattern reversal:

Reversal patterns imply that the current price movement trend is about to change. In other words, if a stock’s price is now rising, it will begin to fall, and if it is currently dropping, it will begin to rise. There are two major reversal patterns to be aware of:

• Head and shoulders and inverse head and shoulders: When three successive waves emerge on a stock price chart, the head and shoulders pattern is formed. It’s seen in the diagram below.

Look at how the crest of the middle wave is higher than the other two. As a result, it is referred to as the head. The left and right shoulders, respectively, are the other two. After a strong ascending pattern, a head and shoulders pattern usually develops. The first (left) shoulder’s apex is higher than the rally that preceded it. It is distinguished by very large market quantities. The subsequent drop is swift, bringing the price back to the place where the shoulder first appeared. It’s characterised by little volume. The pattern’s next phase is the formation of a head through a larger up-move. It’s characterised by low volumes once again. This is followed by another drop, bringing the price back to where it was on the previous two instances. It’s referred to as the neckline. The formation of the left shoulder and subsequent collapse is the third motion. The price does not increase after that, and a long-term price decline begins. To put it another way, the reverse has begun.

Pattern for the Head and Shoulders

The following formula gives the price objective for the reversal, i.e., the price at which the decline will end:

Price target = (Price at the head – Neckline price) x (Price at the neckline) x (Price at the neckline) x (Price at the head – Neckline

OR

Neckline price – Price at the head + Neckline price = Price objective

The reversal of an uptrend is shown by the head and shoulders pattern. However, as a reversal pattern, it should also signal the conclusion of a downtrend, i.e. the end of a period in which prices have been declining steadily. When the head and shoulders pattern is produced in an upside down way, it indicates such a reversal. The inverted head and shoulders pattern is thus named. In water, it looks precisely like a head and shoulders design. There are three inverse waves in this scenario, with the middle one having the lowest bottom. It is shown using an image below. It foreshadows the arrival of an era marked by soaring stock values.

To learn more about SEBI’s stock market regulations, see here.

Pattern with Inverted Head and Shoulders

• Double tops and bottoms: After a large increase, a double top might form. However, instead of three waves, it only has two. Unlike head and shoulders, both peaks have the same price. The longer the time between the two waves and the greater the distance between them, the greater the fall when the trend ultimately reverses. In the event of double tops, the formula for determining target price is the same as for head and shoulders. A diagram of the double tops design is shown below:

Pattern for Double Tops

The reversal of a downtrend is also signalled by a variation of the double top pattern. The design is known as the double bottom pattern. It comes after a period of consistently declining prices and resembles a watered-down version of the double top pattern. A diagram of the two bottoms design is shown below:

Patterned Double Bottoms

The triple tops and triple bottoms pattern is a variation of the double tops and bottoms design. It resembles the head and shoulders pattern, however it only contains three heads instead of shoulders. To put it another way, the peak and all three waves have essentially the same form.

Patterns of continuation:

Continuation patterns provide assurance that the trend that was displayed in a stock chart before to the pattern’s formation would continue in the future. As a result, if the price was rising, it will continue to rise. If it was already trending downward, it will continue to do so. There are three popular continuation patterns:

• Triangle pattern: When the difference between the tops and bottoms on a stock chart is consistently decreasing, a triangle pattern is generated. As a consequence, if trend lines are drawn for the tops and bottoms, they will converge. This will make the design seem like a triangle. The gap between tops and bottoms narrows for one of three reasons: bottoms are rising while tops remain constant, tops are decreasing while bottoms remain constant, or both tops and bottoms are convergent. Ascending, descending, and symmetrical triangles result from these patterns. In a technical chart, all of these indicators imply that the present trend will continue.

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In an ascending triangle, the highs remain steady as the lows rise. Increasing lows indicate that despite the high price, investors are interested in purchasing the stock. This implies that when additional investors purchase, prices may rise even higher. As a result, the tendency remains unchanged as before the pattern developed. In a declining triangle, the tops decline while the bottoms remain steady. This indicates that, despite the stock’s declining price, investors remain uninterested in it. This means that prices will continue to decline as sales grow but there is minimal demand. Tops keep decreasing and bottoms keep rising in a symmetrical way. This suggests that current vendors want to sell and existing buyers want to purchase more. Eventually, the two come to an agreement on a price. Prices then continue in the same direction as they were before to the development of the pattern. The following is a diagram of a symmetrical triangle:

Triangle Pattern with Symmetry

Rectangle pattern: When a stock’s price moves inside a range, it forms a rectangle pattern. Every upward movement comes to a halt at the same point, and every downward movement comes to a halt at the same point. In other words, the top and bottom prices have remained unchanged for a long time. When you build a channel, you’ll see that the trend lines that emerge are parallel. They resemble a rectangle when put together. This indicates that investors are frequently purchasing the stock at one price and then selling it at a different one. As a result, distinct support and resistance levels emerge. Because neither buyers nor sellers of the stock can agree on a price, the stock chart will continue to trend in the same way it has been. A bullish triangle is a rectangle that forms after a lengthy bull run. It signifies that the rising trend will continue. A bearish triangle is a rectangle that forms after a protracted bear run. It suggests that the declining trend will continue. The following is a diagram of such a triangle:

Triangle Bearish Pattern

Flags and pennants: Flags and pennants are shapes that are comparable to rectangles and triangles. They are, however, only visible for a limited period of time. Rectangles and triangles are often seen on technical charts over extended periods of time. Long-term price shifts are also a result of them. Flags and pennants, on the other hand, are only visible on intraday charts, generally for a week to ten days. Two parallel trend lines, created by tops and bottoms that are increasing/ dropping at the same pace, produce a flag formation. A flag formation develops when the current chart trend is in the opposite direction. If the price has risen in the run-up to the formation, for example, the parallel flag formation will trend downwards. It will, however, signal a continuation of the rising trend, as it did before. The flag will be upward-bound if the price has been trending downwards. In the intraday chart, however, it will signal a continuation of the negative trend.

Pennants and triangles are almost similar. The main distinction is that triangles predict the continuance of long-term trends, while pennants predict the occurrence of short-term trends.

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