Editor's note: After TSC columnist Andrew Greta completed his three-part series on stock-picking, we received many requests for more information on how to use charts. Now Greta's back with a two-parter on charts. Let us know what you think.
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If you're like a lot of beginning investors, clicking on the
is kind of like sitting down to a full-blown French meal for the first time -- you can't read the menu and you discover a confusing array of utensils at your disposal to use with your dinner.
Fear not. Help has arrived. The following discussion should provide enough information to help you find your way around the table and keep you from drinking out of your finger bowl.
The Charting Basics
First, let it be said that the process of "technical analysis" (divining the future price of a security by scrutinizing the entrails of past price and volume information contained in stock charts) is the bailiwick of the short-term and day trader.
I'm not a technician, but back in my brokerage days I frequently used charts to supplement other research when advising clients and deciding on stock picks. Over the years, I found that even long-term investors can extract some extremely useful tidbits from stock charts to help them make better trading decisions.
Since I'll be referring exclusively to the features of BigCharts (not only one of the most comprehensive charting services I've ever seen, but totally FREE to
members), you might want to print this article and follow right along with your browser.
Getting to Know BigCharts
When you first pop onto the
BigCharts page, a 1-year shot of the Dow Jones Industrial Average will emerge as the default setting. To get a current quote and 12-month graph of any stock, just enter the symbol or company name at the prompt and click "Draw Chart."
Share price is displayed in the top box, with daily trading volume on the bottom. This is the charting equivalent of hitting the corner drive-through for a burger and a shake. Not exactly haute cuisine, but a great way to stave off those hunger pangs and get a feel for the tool.
It also gives you the opportunity to practice reading some basic chart patterns. Take a minute, check a few of your favorite picks and try to identify some key features. Look for trends (consistent moves in either direction for a period of time); basing patterns (periods of relatively flat prices); and support or resistance points (a particular price level that's been approached several times but not breached). (For fuller definitions of these terms, click
technician Gary B. Smith's recent primer.)
The true chartist uses a bevy of complex patterns with names like "Head and Shoulders Top" and "Double Bottom" to forecast trend reversals, but even the basic concepts can help an investor make smarter choices. Buy into uptrends or breakouts (basing patterns that pierce a resistance level) and steer clear of downtrends or breakdowns (prices that fall through an established support level).
When you're ready for a sit-down meal, hit the "More Options" button and a series of pull-down menus will appear.
If you're basically a meat-and-potatoes kind of investor, most of the available options are going to be pretty esoteric and about as useful as a shrimp fork and a brandy snifter at a backyard barbecue. Buried in this mess of utensils, however, are some good old-fashioned knives and forks that can serve you well in a variety of investment settings.
Your first customization choice is to pick the time frame and frequency for your chart. For the long-term investor, I've found that anything from one to five years is a good starting point, with price information displayed on a daily basis. Sometimes it's helpful to expand your horizon over an even longer period to see how an issue reacted during a particular event or economic cycle (during the Gulf Slaughter or Hillary's stab at nationalized health care, for example). In that case, choose "1-Decade" for time frame and "Weekly" for frequency to keep the chart from getting too cluttered.
Next, you have the option of choosing your price display. Everything from bar charts to candlesticks are offered. Unless you've done enough independent study to tell your "Dragonfly Doji" pattern from your "Dark Cloud Cover," just leave the box on the industry standard OHLC (Open High Low Close).
Occasionally, you may want to set up a "Logarithmic" chart when looking at periods of 10 years or more, because a regular arithmetic chart tends to distort price data as a stock appreciates over time. To understand this, remember that a 10-point move on a $100 stock is a lot less significant than a 10-point jump back when the stock was at $20 (a mere 10% gain versus 50%). Yet these moves show up as equivalent distances on a regular chart since the numbers are evenly spaced on the vertical axis.
A logarithmic presentation corrects the distortion by squishing the upper prices together on the display so that equivalent distances on the chart are actually equal percentage moves for the underlying security. This means that you can more accurately compare both the growth rate and volatility of the investment between different time periods.
I liken the results to one of those funky oval maps of the earth that reduces distortion so that Alaska doesn't end up looking bigger than the former Soviet empire. To see the difference, first take a look at this arithmetic 10-year chart of
Under the regular OHLC paradigm, the price looks like it's accelerating upward and about to go geometric. On a logarithmic chart without the price distortion, the growth looks considerably less torrid and more predictable (see below).
BigCharts also gives you the option of comparing your pick to another stock or index on a percentage basis. This can be useful when choosing between two different mutual funds, for example, or gauging how your stock correlates with the market or another stock in the same industry.
Enough for now? Play around a bit, and we'll continue tomorrow.