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Ed. Note - This mailbag article first appeared on StockCharts.com back in 2000. It is just as valuable now as it was then, so we've added them to our new Mailbag blog. Enjoy!
Q: I have been trying to learn how to develop and read charts, but am having problems. It seems to me charting is like programming, either you get it or you don't. I am hoping I am wrong and can begin to recognize patterns with in the charts. With all the various intangibles in charting, I am not sure what variables I should use. Can you recommend how to get started in charting and what variables I should be using to chart a stock?
A: You mentioned that you have read the Education Center, which is great. I want to make sure that you focus in on our "What is Technical Analysis?" articles, - as they address some of what you are asking. I also want to point you to our bookstore which contains additional information.
For lots of people, technical analysis (TA) is an ever expanding set of tools and techniques that can be used to better understand the markets. It is very easy to become overwhelmed. The good news is that the basic techniques are still very useful. I recommend that you focus in on support, resistance, trend, and the simpler chart patterns that are directly derived from them. I'd avoid doing too much with indicators and complicated techniques until you have a solid understanding of the building blocks.
Anytime you learn something new in TA, it is helpful to backtest it by pulling up a couple of charts and hiding the right half with a piece of paper. See if the new technique helps you predict where the visible part of the chart is going. Closely study the areas around price reversals and places where prices stop trending and start moving sideways in a trading range. Look for signals (crossovers, volume spikes, gaps, divergences, etc.) in those areas. If the technique you've just studied helps your ability to predict future changes, add it to your "arsenal" -- otherwise, file it away for later study.
Also, always strive to understand what any new technique reveals about the underlying "mass-psychology" of the market. Technical analysis is most successful when it reveals changes in people's opinions. This is why volume is so important - it can help confirm whether a change is "real" or not.
Once you've spent time with the basics -- support, resistance, trend -- it's time to get familiar with some indicators. Again, the basics are your friend. Simple moving averages, MACD, and RSI are the best ones to start with. Apply the same techniques I mentioned above -- backtesting and so on. Each indicator has a "personality" that you need to discover. None of them are perfect, alone or in combination. All they can do is reduce some of the uncertainty about stock movement. As you backtest them, you will find that under certain situations some indicators give very good buy/sell signals and others don't. Keep experimenting until you have a feel for the strengths and weaknesses involved.
When you've become familiar with an indicator, check out our daily Scan Results for that indicator in our Stock Scans section. See if you can spot promising stocks from the list and then track their results over the next few days/weeks/months.
One final suggestion: Learn from the pros! Read our ChartWatchers newsletter and/or John Murphy's Market Message. Look at the charts that accompany those articles and see if you agree or disagree with what the author is saying, then clearly write down why you agree or disagree.
Stick with it for a couple of weeks (at least) and more and more things will fall into place. Let us know how it goes!
- Chip Anderson
