Technical Stock-Picking: How to Trade Off of a Stock Chart

This technical analysis-based assignment was written by Stockpickr member Ira Krakow.

Instead of trying to outsmart the large institutional "elephants," why not join them?

If the big hedge funds , mutual funds , institutional investors and players such as Warren Buffett, Carl Icahn and George Soros (who have billions of dollars to invest, huge research budgets) are buying and selling a stock, then that activity will be reflected in the stock chart -- the graph of the stock's historical price over time.

If a stock's chart is showing that an institutional feeding frenzy is taking place, we might want to join the feast. So instead of buying and holding, we can enjoy the ride up until the chart tells us that the party is over, at which point we would sell.

The key to tracking the elephants: Understanding how to read a chart. A stock chart has three components: price, volume and time frame. Let's look at each of them.

Price. Price is the obvious starting point. Stock prices essentially follow the law of supply and demand. When more investors want to buy than sell, the price rises. When the opposite is true -- there are more sellers than buyers -- the price falls.

Volume. The real key to chart reading is a stock's volume . Typically, only a fraction of a company's stock trades on any given day. Breaking news, such as an earnings surprise , a new product announcement or a pending merger , usually causes the volume to spike, indicating increased investor interest. (The news itself can be either positive or negative.)

Here's a one-year (2007) chart of Google GOOG, showing both price and volume fluctuations:

Google 1-Year Chart

Click here for larger image.

Source: Yahoo! Finance

Notice that the daily volume trended in a range of 5 million to 6 million shares (for a recent range, check out the box labeled "Avg Vol (3m)" on Yahoo! Finance's GOOG quote page), but that significant spikes did occur during the year -- at one point, increasing to almost 18 million shares.

Spikes are typically due to breaking news. For example, Google's daily volume increased to nearly 16.5 million shares in early November, thanks in large part to the Alibaba.com IPO in Hong Kong. Why? Google competitor Yahoo! YHOO is a big investor in Alibaba.com, and that caused some Google investors to sell, causing a drop of over 100 points, from around $741 to $626, in mid-November. Volume confirms the price movement.