Charting is as much an art as it is a science, and learning how to use charts when making investment decisions can prove helpful in many situations.
There are many “Technicians” out there who will base their trades solely on chart information. On the other side of the room are the “Fundamentalist” who base their trades solely on company fundamental data (i.e. demand for the company’s products or services, the costs to produce such products or services, level of competition etc.) and believe that using chart data to predict stock price movement is akin to using a ouija board to predict the future.
I tend to believe in both schools of thought. I strongly believe that company fundamentals should be the driving force behind one’s investments, but I also use the information gleaned from charts to determine entry and exit points for my trades, and to get an idea of how the market views the stock (i.e. is the price going up (high demand), down or sideways (low demand).
Much of the day-to-day trading we now see occurring in markets around the world is driven by very sophisticated computer algorithms which, in many cases, rely on charting information to determine when to execute their trades. If you study chart patterns carefully enough, over time you can get a sense of how a given company’s stock price will behave..
For example: Take a look at the following chart of the S&P and what do you see? A pattern – right?
Click to enlarge
Upon closer inspection we see that from around October/November of 1996 the S&P began its long assent up the dot-com mountain. In November of 2000 we began our long and devastating decent down the mountain until we finally reached the bottom by the end of July 2002. That bottom was retested in October of 2002 and again in early March of 2003 when we began our long assent up the housing market mountain. The S&P peaked on October 11th of 2007 at a price level of 1,576.09. From there it began it’s long painful decent down to a low of 666.79 (scary number – hey?) which occurred on March 6, 2009. The very next day the market started moving up at a fairly steady pace until April 26, 2010 when it reached a peak of 1,219.80 and then started to move down again.
One area I have been watching very carefully can be seen in the area highlighted in yellow. As compared with the market rebound in 2004 (also highlighted in yellow) we have hit an area of sideways movement which is similar to the sideways movements we saw between January through October of 2004. If the S&P were to break down below 1,100.00 we would most likely witness the “double dip recession” that many economists have been talking about for the past several months.
This set of twin peaks and valleys in the S&P demonstrates why it can be useful to study chart patterns. If a trader or investor had purchased the S&P alone at its peak in 2000 it would have taken him or her seven years to reach break-even, which also coincides with the most recent housing market crash. So, in short, charts can be a very useful source of information, and learning how to read them can prove helpful in many situations, especially when trying to time one’s trades or investments.
