Hi All
This posting is a brief outline of two key elements of a stock chart. It is intended to provide some basic thoughts for beginners on how to understand stock charts. Reading a chart is easy, you just need a basic understanding of math. The two fundamental features are: the shape of the line and volume.
Line shape and volume are clearly seen in the example below. The graph below is from the Exxon Mobile corporation. The line represents the market price over the past 30 years. The bars at the bottom are the volume.
In the chart above, the stock price of Exxon has increased steady. The volume has also increased – you can tell because the bars on the bottom part are taller in more recent years. Understanding both of these metrics is important for determining if your stock is a good investment or not. Why? Read on.
1) Volume: This is the number of shares traded withing a given time period. Volume is important for two reasons. First, you want to be sure that you can sell your stock in the event something adverse happens to your company. If the volume is less than say, 10,000 shares traded a day, you might not be able to find a buyer if you want to sell. Second, in technical analysis, a lot of emphasis is placed on volume. High spikes in volume are believed to signify future sharp rises or falls in prices.
2) Shape of the Line: The first thing you want do when evaluating a potential stock buy is scan the price performance over time. Stock prices usually follow earnings. Prices often have a schizophrenic relationship with the underling value of the company, but prices do matter. All things being equal, more profitable business command a higher price, less profitable business have lower valued shares.
So, if you are buying to hold, you should be looking for a graph that shows a steady upward movement over time – the pattern shown by the Exxon graph (above). This indicates that the company you are buying has increasing earnings over time. On the other hand, if the stock is headed downwards, there might be problems with the company’s underlying economics. I added the 1 year chart of Starbucks stock (below) so you can see what what we mean by a stock that’s headed downwards.
HINT: Starbucks is having financial trouble. Its reflected in their share price. So, basically shares moving up = good, shares moving down = bad.
Of course, looking at price charts is not a substitute for doing due diligence – do your homework when buying stocks. That said, if you’ve got to screen a lot of stocks – a steadily upward moving line is a good way to separate profitable companies from the dogs.
For more information on understanding stocks, I recommend you find a copy of the Forbes: Guide to the Markets. Its an easy read and answers most questions on stock charts.
Best,
James
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