A Picture is Worth a Thousand Words – Stock Charts 101

This article attempts to:

Explain what a stock chart is
Introduce two common types of stock charts
Explain why you should familiarize yourself with stock charts

AlphaInvestors believes ALLinvestors should know if the economy is doing well or poorly and what direction the stock market is trending. Investors will generally find it easier to increase their wealth when the market is trending upwards than down or sideways, “A rising tide lifts all boats”, commonly attributed to a John F Kennedyspeech.

The good news for you is that ascertaining the direction of the market takes very little effort on your part!

Why you should be familiar with stock charts

The primary use of stock charts is to assess the market direction, Figure 1. The market has three possible trends:

Up – positive slope
Sideways – no discernable slope
Down – negative slope

Figure 1 An investor can quickly discern the direction or trend of the market, up, sideways, or down by simply looking at a chart. Three charts showing the SPY ETF over 3-month intervals with equal vertical scales.

Places you can easily find a chart of the most common market indexes mentioned by the media:

S&P 500 –

S&P Dow Jones Indices (select 1 Year or YTD – Year-To-Date)
Google (select 1Y or YTD – Year-To-Date)
Yahoo! Finance (select 1Y or YTD – Year-To-Date)
Your broker

Dow Jones Industrial Average –

S&P Dow Jones Indices (select 1 Year or YTD – Year-To-Date)
Google (select 1Y or YTD – Year-To-Date)
Yahoo! Finance (select 1Y or YTD – Year-To-Date)
Your broker

How would you assess the direction of the market in 2018?

Figure2 Charts showing the S&P 500 index performance as of July 20, 2018. Source: S&P Dow Jones Indices.

What is a Stock Chart?

The best way to assess the direction of the market is to look at a chart, Figure 3. A chart is a historical graph of price (on the ordinate – vertical axis) vs. time (on the abscissa – horizontal axis) of a security (stocks, ETFs, options, futures, etc.). Investors can quickly discern the direction of the market by looking at a chart similar to following your progress on a map during a road trip. Unlike a map, the one thing a chart can NOT tell you is where the market, a stock or an ETF will go. In finance, technical analysis is the study of historical price data with the intent of forecasting future price movements.

Figure 3 Typical stock chart of the Exchange Traded Fund (ETF) SPDR S&P 500 (SPY). ➊ Time Axis; ➋Price Axis; ➌Volume Axis; ➍Ticker or Index; ➎Closing Price; ➏Change in Price by $ and %; ➐Number of shares traded in a day; ➑50-Day Moving Average (DMA); ➒Price Pane – an historical plot of price versus time; ➓Volume Pane – an historical plot of trading volume versus price.

Types of Stock Charts

Two of the most common types of stock charts are line charts, Figure 4, and candlestick charts, Figure 5.

Line Charts

Line charts are the least complex, but are extremely useful when assessing trends and comparing the relative performance of a security versus an index or another security. Unless otherwise stated, line charts plot the daily closing price of the securities under consideration.

Figure 4 A line chart comparing the Year-To-Date (July 20, 2018) relative performance of the iShares Dow Jones US Technology ETF (IYW) and the iShares MSCI Emerging Markets ETF (EEM) to the S&P 500 index. In 2018, a line chart shows investors should be avoiding the emerging markets (-8.4%), pursuing technology stocks (+13.4%), while the index is little changed (+3.9%).

Candlestick Charts

Candlestick charts are often used by quants, technical analysists, traders, and AlphaInvestors. In addition to trends, candlestick charts provide a wealth of information on what is happening with a security. A candlestick chart provides information on the Opening, High, Low, and Closing price of the security during the time period specified, Figure 5. Bull (up) candles, the closing price is greater than the opening price, are often shown in green, whereas bear candles (down), closing price less than opening price, are shown in red. With a mere glance, investors can ascertain if days, weeks, months, etc. are up or down, in addition, to quickly spotting the trend.

Figure 5 Candlestick basics. Bull candles depict an increase (gain) in price while bear candles depict a decrease in price (loss). Candlesticks require the Opening price, High, Low, and Closing prices (OHLC) for the time period.

Another advantageous feature of candlestick charts, Figure 6, is they are also applicable over multiple time domains, including, intraday, daily, weekly, monthly, etc. AlphaInvestors prefers to look at weekly candlestick charts that filter out the intraday and daily whims of the market.

Figure 6 Candlestick charts aligned to show the daily, weekly, and monthly Open, High Low, and Close (OHLC) price data for the month of October 2011. Volume (not shown) is also typically desired and is shown in a pane below the price pane just as with line charts.

A week is a week, a month is a month, and a year is a year, but when they begin, when they end, and how many trading days they have is anyone’s guess. Fortunately, candlestick charts remove the guesswork and simplify our understanding. Sometimes a week begins in one month and ends in another, explaining the discrepancy between the weekly and monthly candles in Figure 6. October 31, final red daily candle, was a Monday and was associated with the first weekly candle of November. A week may also begin in one year and end in the following year.