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Part 3: Putting it all together

Ok so now that you know what these metrics are, it’s time to learn how to use that knowledge to actually infer something from a chart.

So if someone was to ask me what chart reading is, I would tell them that it’s the graphical (or, chart) version of a verbal statement.

So, let’s take our three main datasets (price, volume, and volatility) and ask ourselves what these might sound like as a verbal statement.

So if I said to you that a stock was “going up”, what would the graph look like in your mind?

I bet it’s something like this, right?

[ATTACH=full]121892[/ATTACH]

Well, actually, yes! This is what we call a trend. 

But that wasn’t too difficult was it, so let’s get a bit more complex. What if you asked me how much I think a stock is worth and I said to you that I reckon a stock is worth “$15 NOW, but it’s going up by $10 a week”. What would that look like?

Hopefully, you’ve thought of something like this:

[ATTACH=full]121893[/ATTACH]

See how we’ve added some specifics here – we’ve added a starting point, a rate of increase, and now have a scale for our time increments and putting this all together we have a trend. 

So let’s take another statement. Let’s say you asked me how much you reckon I think that the EURO is going to be worth in Japanese YEN for the next few days and I said “I reckon it will remain somewhere between 140.6 and 141.5”.

This is where we get to introduce the second of our key datasets aside from just price – we get to introduce some volatility with this statement because we’re implying that the price will be at an unfixed point (i.e it will change).

However, you will also note that I’ve said that I think it will be between two different numbers – I have given you a range that I think it will be in. Now let’s think about this logically: The greater the range that the stock will bounce around in the more volatile it is because it is moving more, or the more volatile it is the larger the range will be (so vice-versa).

Now when I talk about this 140.6 to 141.5 range what I’ve just given you is a floor (minimum) and ceiling (maximum) price I think the stock will be. These are known in trading as “support” (the floor) and “resistance” (the ceiling). These terms obviously mean the same thing and you could consult a thesaurus and use bottom or base or top or peak for more synonyms, but just remember that the particular terms the industry has chosen to use to refer to the bottom and the top of the range are support and resistance.

So again, think in your head what a graph with a “support” of 140.6 and a “resistance” of 141.5 would look like. If I’ve made sense so far, hopefully it looks something like this:

[ATTACH=full]121894[/ATTACH]

And this gives us our first bit of actual real chart analysis. If we can use a chart to identify a range then we can use that range to give us our buying and selling points. Again, if I’ve made sense then when you think in your head where those points should be you should have thought of something like this:

[ATTACH=full]121895[/ATTACH]

So, now that we’ve understood what a stock looks like when it has a trend and a range, let’s put the two together. What if you asked me how much I think a stock was worth and I said to you “Ah well probably somewhere between about $150 and $120 at the moment but I reckon it’ll go up by about $1.25 a day or so”.

Again, think about it in your head. You have both a trend and a range now. What would that look like?

Hopefully, like this:

[ATTACH=full]121897[/ATTACH]

So now that you know what you’re looking at, a stock which moves with both a trend and a range like this is referred to as trading in a channel. 

Now the cool thing with apps like the one I use called “tradingview” is that it has inbuilt little tools that we can use to test our assumptions and draw a point from the middle of our channel at the start of the chart to the middle of our channel and see how we did:

[ATTACH=full]121898[/ATTACH]

As you can see, that’s a movement of about $75 over a period of 60 days so that’s almost bang on $1.25 a day. Cool huh!

So, this has been pretty good so far, but as I’m sure you’ve guessed, perfect little parallel channels like I’ve shown above are not the only way a stock can trade. What if the support & resistance lines were at different angles to each other and the pattern was more of a triangle than a rectangle?

Well, actually, yes, there is a name for that: It’s called a wedge pattern.

[ATTACH=full]121899[/ATTACH]

[ATTACH=full]121900[/ATTACH]

Now those of you who have followed everything closely and understood things well should be able to deduce that a wedge pattern is when a stock has a trend and range but its volatility (and therefore its range) is decreasing. This means that your opportunities to get in & out at support & resistance get smaller and smaller as time goes on, but your overall trend becomes more and more certain.

Incidentally, there are also patterns referred to as broadening wedges where the volatility is increasing (and thus the trend is becoming less and less certain) which work in the opposite way:

[ATTACH=full]121901[/ATTACH]

[ATTACH=full]121902[/ATTACH]

But it is my very firm opinion that trying to trade these is playing with fire and thus should be avoided.