How to Read Charts, Part 2

OK, now where were we? Oh, right. I was just about to give away my last three chart-reading "secrets," thereby enabling you to make millions a day in the market!

Or, something like that. In any case, if you haven't, please go back and read my Monday column so that we're all on the same page. OK, good. Now let's jump in with steps four through six and finish up with a few chart examples.

Step No. 4: Identify any high-volume moves. Similar to Step No. 2, where we identified any chart highlights, here we want to zero in on any specific high-volume periods. Why high volume? Price action is one important part of a chart, but I have found volume surges to be of equal, if not greater, importance. In fact, it is rare when a high-volume surge doesn't identify an important aspect change in a chart, so we certainly want to note anything unusual.

By the way, what do I mean by high volume? Usually, any volume spike that is at least 150% above the 50-day moving average of volume can be considered a volume surge. However, as you'll see on the charts below, volume surges are pretty easy to pick out.

Step No. 5: Note the overall volume trend. This step is probably the single most overlooked step in reading charts, but perhaps the most critical. The trend of the volume -- whether it's climbing, declining, or staying static -- can tell you everything. For example, if a stock is pulling back after a breakout, seeing declining volume is a great clue that the pullback is buyable. Similarly, if volume had been declining, and it then surges on a breakout, that tells you the breakout is probably valid.

You'll note that, on most of the charts I show in my various columns, I indicate how the volume trend is giving me some guidance on reading the chart. Now, can you read charts without noting the volume? Sure, but it'd be like playing golf without a wedge and driver: doable, but why not use the extra clubs?

Step No. 6: Formulate a "what if" scenario. Now we come to the payoff step. If steps one through five helped you read a chart, this step starts to turn this chart reading into a trade.

At this point, assimilate all you know about the chart and come up with a plan of attack that either gets you a low-risk/high-reward entry or brings you to the conclusion that the chart won't make a good trade. Remember, there is a huge difference between reading charts and trading. I draw conclusions on a lot of charts every day, and think I have a good feel for many of them. However, maybe only a handful jump out as good trades. And it's only the latter group that I want to trade.

OK, now let's look at the final three steps and figure out if we can come to any conclusions on some good trades to make.

So, in summary, what have we done? Well, all we did was break chart reading into six pretty straightforward steps. And, really, that's exactly how I do it. There are no other indicators, no other signals. Just price, volume, trend, support and resistance. Keep it to those basics, stick to the charts that look obvious, practice a lot, and you'll significantly improve your trading. Or, at the very least you'll be able to send me an email saying I don't know beans about my latest charting conclusions!