Learning how to read stock charts is one of the most important investing skills you’ll ever learn. Using stock charts leads you to stocks to watch like Nvidia (NVDA), Yeti (YETI), Square (SQ), Amazon.com (AMZN), DocuSign (DOCU), Veeva Systems (VEEV), Netflix (NFLX) and Datadog (DDOG) in the early stages of a big move.
Learning how to read stock charts also helps you spot support and resistance and when to sell stocks. It will also help you find and handle IPO stocks to watch like Concentrix (CNXC), CrowdStrike (CRWD) Hayward (HAYW) and Traeger (COOK) as they join the IPO Leaders screen.
While not on that stock screen, Napa Valley-based winemaker Duckhorn Portfolio (NAPA) is also among the top IPOs to watch since going public in March. Duckhorn was recently featured in the IBD Stock Analysis.
You’ll find that the behavior of stocks to buy and watch like Amazon, Nvidia, SQ stock, Netflix, Veeva, Yeti, Datadog, DocuSign and others around their key moving averages provides crucial insight into their health. Understanding the stock chart action around the 21-day, 50-day and 10-week lines is crucial in helping investors decide whether to buy, sell or hold.
In part 1 of this series on chart reading for beginners, we answered two basic questions: Why use charts? What’s in a stock chart?
In this second installment, we go over three telltale clues to look for in a stock chart to hone your stock-picking skills. These clues help you pinpoint the best time to buy stocks and when to sell or hold. Once you know how to spot these signals and understand the concepts behind them, you’ll be ready to capture solid gains with the three most profitable chart patterns.
How To Read Stock Charts: Keep It Simple
It’s easy to overcomplicate chart reading. But as we saw in part 1 of this series, charts simply tell you a story. And to understand what tale is being told, you really just need to answer the three basic questions discussed below.
So when it comes to how to read stock charts, keep it simple. You’ll be surprised by how much you can learn about the health and potential of a stock just from these three clues.
Editor’s Note: If you come across terms or concepts you’re not familiar with, check out How To Read Stock Charts: Part 1 of this series for more details.
1. How To Read Stock Charts: What’s The Trend?
The first question to ask when looking at a stock chart is, “What’s the trend?” There are basically three possibilities: uptrend, sideways, downtrend.
As simple as that concept may sound, it’s also quite important. You want to buy stocks when they’re going in the right direction — up.
Take a moment using IBD charts to identify the trends for Netflix, Nvidia, Amazon, Yeti, Veeva, DocuSign, Datadog or any stock you’re tracking. Start learning how to read stock charts by first identifying the current trend in these stocks to watch.
Why buy a stock that is clearly heading south? Yes, it may eventually find a bottom and reverse that trend. But why jump in when it’s headed the wrong way? Wait until it shows clear signs of renewed strength and begins moving in the right direction.
When a stock is moving sideways, there’s no clearly defined trend. You don’t know if the stock will jump higher or take a nose-dive. Again, why take the risk at this stage? You’re better off waiting for the stock to show signs of a new uptrend.
Understanding if we’re trending up, down or sideways is especially important when trying to navigate stock market volatility.
2. What ‘Story’ Is The Stock Chart Telling?
Stock charts tell a story. They show you if a stock is being heavily bought or aggressively sold by large investors. But the only way to decipher that story and begin understanding how to read stock charts is to look at the changes in share price together with the changes in volume (i.e., the number of shares traded that day or week).
Share prices of the leading stocks to watch fluctuate daily, up or down. To see if the buying or selling is serious — and to see if the underlying trend is changing — you need to check the volume.
For example, say a stock normally trades 1 million shares a day. If the share price rises or falls a bit one day and volume is around 1 million shares, that’s nothing unusual. But if the stock suddenly trades 3 million shares one day as it gains 5%, you know something is up. You want to pay particular attention to those kinds of unusually heavy-volume days or weeks.
Let’s look at some different scenarios and what they mean. While looking at the examples below for Netflix stock, Nvidia stock and others, keep in mind that these concepts never change. The companies, technology and stock market cycles will change, but the underlying concepts remain the same.
Price GAIN in unusually heavy volume: Look at the weekly chart for Netflix below. NFLX stock began one strong climb in 2016, then ran into resistance in July 2018. As indicated by the arrows in the chart, there were several weeks where Netflix’s share price rose sharply and volume also spiked. Even before the 2020 pandemic increased demand for streaming services as people stayed at home, Netflix stock was rising as the best mutual funds scooped up shares.
What story does such behavior reveal? That mutual fund managers and other large investors are aggressively buying shares. This so-called “institutional sponsorship” is exactly what you want to see. It’s these large investors that provide the fuel a stock needs to make a sustained climb.
See the current chart for Netflix stock and look at how NFLX is forming a new pattern while testing support and resistance right along its 10-week moving average.
Nvidia, which rose 750% after being highlighted in the IBD 50, offers another example of strong institutional demand. In the daily chart below, look how the stock was trading in a tight range right along its 50-day line in April and May of 2017 (1). The stock then gapped up on May 10 in volume 268% higher than normal (2). And note how volume continued to come in well above average as the stock moved higher in the days that followed (3). Large investors were clearly in buying mode. The stock spiked again in heavy volume on June (4).
Now see the latest stock chart for Nvidia. NVDA stock has shown similar heavy buying from mutual funds and other large investors as it has rebounded to another round of all-time highs. Showing its power as one of the best growth stocks to watch, NVDA stock has earned a spot on the IBD 50, IBD Big Cap 20 and Leaderboard.
As with Netflix, Nvidia stock shows how these chart patterns and telltale traits repeat year after year.
Price DROP in unusually heavy volume: This is the exact opposite of the scenario above. A large drop in price accompanied by a big spike in volume shows that large investors are aggressively dumping shares. In other words, the selling is serious. As the example of 3D printing stock 3D Systems (DDD) shows below, it’s especially worrisome if the stock is crashing below the 50-day or 10-week moving average line when that happens.
Look how volume rose sharply as the stock crashed right through its 50-day line (1). And the same thing happened as the stock failed to find support at the 200-day line (2). These were both signs that after a big run prior to 2014, 3D Systems’ trend had changed.
Fast-forward to today. After rebounding sharply beginning in November 2020, 3D Systems has once again become volatile, dropping back below its 10-week line.
Price GAIN in unusually light volume: If the share price is rising significantly, but volume is normal or below average, what does that tell you? That, at least for now, large investors are not buying aggressively. In other words, there’s not a lot of conviction for the move.
Such moves can turn out to be a head fake, which was the case for Old Dominion Freight Line (ODFL) in the chart below. The stock broke out from a base, but volume was well below average (1). On the day of a breakout, you want to see a 40% or larger spike in volume to show strong demand. Old Dominion fell well short of that.
In the days that followed, note how volume rose sharply as the stock fell (2, 3). So a light-volume breakout attempt turned into a heavy-volume sell-off. Such behavior is a clear sign that large investors are in selling, not buying, mode.
Today, ODFL stock has successfully found support at its 10-week line as the trucker tries to roll right into a new breakout and all-time high.
Price DROP in unusually light volume: When a stock falls but the number of shares traded is much lower than normal, it tells you that large investors are not selling aggressively. This is an important clue that can help you sit tight and hold on for bigger gains down the road.
The example of Ollie’s Bargain Outlet (OLLI) below proves that point. While Ollie’s was building a new flat base, note how volume on down weeks was below average (1). It was also finding support at the 10-week line. As the arrows in the chart indicate, the stock broke out of that base in heavy volume and showed several heavy-volume up weeks as the stock climbed higher for months. It’s a clear example of how you can see what fund managers are up to by looking for unusual spikes in price and volume in a stock chart.
See how OLLI stock is performing after recovering now from a sell-off in 2018. Note how it briefly jumped out to a new all-time high in January, before hitting resistance and pulling back. OLLI stock is now testing its 10-week moving average.
In addition to reviewing Ollie’s, take a look at Nvidia, Veeva, Netflix, DocuSign, Datadog and other stocks to watch on IBD stock lists. The names constantly change, but the chart patterns do not. Year after year, decade after decade, these same patterns repeat themselves — the same stories, told by different storytellers.
3. Is The Stock Finding Support Or Hitting Resistance?
Last but not least, see if your stock is finding support or running into resistance at key lines like the 50-day and 10-week moving averages. Also look for support or resistance at important price areas, such as new or recent buy points in a chart pattern.
How your stock performs at these testing grounds reveals a great deal about its strength. Why? Because many fund managers and other large investors closely follow these benchmarks.
If these big players still favor the stock, they’ll often step in to pick up more shares and protect their positions when it pulls back to the 50-day or 10-week moving average. Their buying will keep the stock above those benchmarks. But if the stock crashes below the moving average in heavy volume, it’s a sign that large investors have shifted into selling mode.
Take Alarm.com (ALRM) as an example. As it was making a nice run in 2017, the stock consistently found support at its 10-week moving average (1, 2, 3). It was in a clear uptrend, and there were several heavy-volume up weeks — a sign of institutional demand.
But note how that trend changed toward the end of that year. The stock failed to find support at the 10-week line and crashed below it in heavy volume (4). After that, note how the 10-week moving average changed from an area of support to a line of resistance (5, 6).
To expand your understanding of how to read stock charts, take a look at how ALRM stock has behaved recently. It hit resistance in July 2020 then found support at its 50-day moving average in October. Alarm stock went on to form a cup-shaped base, then broke out to a new all-time high. It has since pulled back to test its 10-week line, which has been trending lower.
Lines of defense: You can think of the 50-day and 200-day moving average lines as a stock’s first and second lines of defense. (On a weekly chart, the equivalents are the 10-week and 40-week moving averages.) If a stock fails to find support at the 50-day line, see if it can at least hold its ground at the 200-day moving average. In the case of 3D Systems discussed earlier, you can see how the stock failed to find support at either benchmark, and crashed below both of them in heavy volume (1 and 2, above).
Steppingstones: E-Trade Financial (ETFC) shows how stocks will often form steppingstones as they climb higher. This happens as the stock hits resistance (1) and pulls back, then finds support (2) and rises again. It’s very healthy action to see a stock turn a former ceiling of resistance into a new floor of support.
Editor’s Note: In October 2020, ETFC stopped trading after Morgan Stanley (MS) purchased E-Trade.
How To Read Stock Charts: Bases, Buy Points And Breakouts
In the next installment of this series on chart reading for beginners, we’ll go over the three most profitable chart patterns: cup with handle, double bottom and flat base.
As we do that, you’ll see how each of the three telltale clues discussed above come into play:
- Each chart pattern or base must be preceded by a prior uptrend.
- The bottom of the base is an area of support, and the buy point is based on a former area of resistance.
- Breakouts happen when the stock punches through that area of resistance in unusually heavy volume.
You can also learn more with our free lessons on how to read stock charts. Or take a free trial of Leaderboard to get timely alerts to stocks to watch, as well as ongoing highlights of bases, buy points and sell signals. It’s an excellent way to get real-time chart-reading tips while building an actionable watchlist.
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