What is the best charting method for stock trading?

What is the best charting method for stock trading? A simple answer could be – The method that best suits your trading style. But that answer is as good as useless so here is a better answer.

The best charting method for trading is drawing simple levels of support, resistance and price channels on 6-month daily candlestick charts. Watch price, 200-day and 50-day moving averages, candelstick patterns, classic price formations and volume for confirmation. 

In a nutshell

Here that is again but filling out a little more detail.

• Determine the general market trend,
• The main market indexes.
  • Are they up? down? topping out? or bottoming out?
• Breadth indicators, advance-decline line, bullish percent index.
  • Broad market or thinning out?
• Find your sector – look at the Standard and Poor’s 500 sector ETF relative performance – perf chart.
• ETF approach
  • choose the top three or four sectors.
• Stock approach
  • look for strong stocks in the top three or four strongest sectors

For short to intermediate term positions

• Look at the last 6 months candlestick chart
• Look at last 2 years of weekly line chart
• Look at 10 years of monthly line chart
• If it helps, add a long-term moving average and a short-term moving average
• Look back for major price support and resistance
• Look for price channels, candlestick patterns, and classic price formations

For long term positions

• Look at 10 years of monthly line chart
• Look at 2 years of weekly line chart
• Use 200-day and 50-day moving averages
• For timing look at the last 6 months of daily candlestick chart
• Look for major price support and resistance
• Look for price channels and classic price formations

Find the general trend

Our first task is to determine the general direction of the market and how broad support for that direction is.

Here we are going to follow the sequence to look for short to intermediate-term trades.

There are a few indicators we can refer to for the general market trend. The obvious ones are the headline indexes like the Dow Jones Industrial Average, or the DJIA, the Standard and Poor’s 500 Index, or the S&P 500 and the Russel 2000.

The DJIA is the one most talked about on the news. It doesn’t really mean much in terms of stock prices but because it gets the most attention it is worth being aware of.

The S&P 500 is a large-cap index. But because it is cap-weighted the index is easily distorted by the stock prices of the top ten or twenty stocks in the index. The Russel 2000 is an index that tracks small-cap stocks and gives a view of that corner of the market.

The Russel 2000 is also an indicator of the breadth of a market movement.

Here is what they all looked like on 27 October 2021. We are using Exchange-traded funds, ETFs that track each of the indexes very closely. DIA tracks the Dow Jones Industrial Average, SPY tracks the Standard and Poor’s 500 Index, and IWM tracks the Russel 2000.

¹⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

To my eyes that is a broad picture of rising markets over the last five years with the occasional pull-back that lasts a few months or so. The most noticeable pull-back was the COVID low of March 2020.

If we just focus on the current year, 2021, both the Dow Jones and the S&P 500 made significant advances. However, the same cannot be said for the Russel 2000. Since late June 2021, the Russel 2000 was trading sideways and only in late October 2021 did it break new highs.

Let’s take a closer look at the last few months.

²⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

Here, rather than compare the absolute dollar values of each we are looking at the relative performance of each index taking the price on 2 August 2021 as the baseline. We then track the performance of each index as a percentage change relative to its price on 2 August.

We can see that each index went sideways through August to around early to mid-October when they all put in gains again. This time the small-cap index, the Russel 2000 led the field gaining over 8 percent, the Dow Jones gained just under 6 percent, and the S&P 500 around 3.5 percent. Then from the beginning of November, all three indexes have gone sideways.

From these major indexes, it looks like we are still in a generally upward moving market with some evidence of pulling back.

To get a better sense of where the whole market is at present, we should next be looking at breadth indicators. Market breadth basically means the proportion of stocks in a market that are participating in the main movement of the market. A broad market is a strong market while a thin market is a weak market.

If market breadth starts thinning out while the main headline indexes are still advancing this is an indicator that a reversal to the downside is likely. The converse is true in a declining market. Market breadth often acts as a leading indicator, but not always.

Understanding market breadth is an essential part of understanding where the market is going and how strong and well-supported that movement is.

Breadth indicators

There are a few breadth indicators we can look at.

The advance/decline line is one common indicator of market breadth. The advance/decline line is a simple calculation. You take the number of stocks whose prices have increased in the last day, subtract the number of stocks whose prices have decreased in the last day, and add that number to the advance/decline number of the previous day.

So the advance/decline line is a cumulative index calculated from the previous day’s value.

So when more stocks are advancing in price, the line slopes up. When more stocks decline in price, the line slopes down. You need to look at the advance/decline line together with the general market.

You can also look at the advance/decline percent. The advance/decline percent tracks changes in the advance/decline line starting with zero percent at a specific date of our choosing. The advance/decline percent then moves above or below the zero percent line which is usually the date we start our chart.

The advance/decline percent tends to amplify movements of the advance/decline line. Here is the advance/decline percent for the Standard and Poor’s 500 Index from 12 June 2021 to 12 November 2021.

³⁾Source: Stockcharts.com

That is actually hard to see what is going on. So let’s add a 20-day moving average, and let’s compare with the S&P 500 price for the same period. The 20-day moving average reduces the noise and makes it easier to discern the direction of the advance/decline percent.

⁴⁾Source: Stockcharts.com, Yahoo Finance, chart by Badinvestmentsadvice.com

Here we’ve added some notes on the charts to highlight a few things.

⁵⁾Source: Stockcharts.com, Yahoo Finance, chart by Badinvestmentsadvice.com

Firstly, there was a period of sideways price movement between early July and early September. Then there was a period of price decline that lasted to mid-October. And then the price rose.

Matching up the advance/decline percent with the price, we see that during the sideways period the advance/decline percent line held roughly level. This suggests there was no significant change in market breadth. Then when the price declined we see the advance/decline percent line also declined. Similarly, when the price was advancing we see that the advance/decline percent line was also rising.

All of this indicates that market breadth matches the price action. We can take that as a confirmation of the price movement.

If there is one warning sign, we should note here, it is that trading volume increased when the Standard and Poor’s dropped around the beginning of October. But then when the price advances from mid-October onwards this happens on lower volume.

That is an indication that the move is not strong and likely to reverse.

Bullish percent index

Another important breath indicator to check is the bullish percent index. To get a sense of the whole US market it’s best to look at the New York Stock Exchange or NYSE bullish percent index.

⁶⁾Source: Stockcharts.com

This chart actually shows the bullish percent index for all, roughly 2,800 stocks on the NYSE that were on point and figure buy signals since October 2017. If you are not sure what that means, here is an article that explains the bullish percent index and how to read point and figure charts.

Before we move on, it is worth looking at the general picture the point figure chart presents. Here would be some observations.

One thing we can see is that the chart seems to spend a large proportion of its time in the high 60 percent range. We can also clearly see the major market pull-back at the end of 2018 when the BPI got down to 20 percent before heading back up starting in January 2019. Another clear feature is the COVID crash of March 2020 and the V-shaped recovery from there.

We want to hone in on more recent price movements so let’s focus on what happened since January 2021. And for comparison let’s look at the relative performance chart of the DJIA, the S and P 500, and the Russel 2000.

⁷⁾Source: Stockcharts.com

⁸⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

So from January through early June 2021, the NYSE BPI spent most of its time in the 70 percent range. Then through June and July, it dropped down to 50.

Then from around mid-July, the BPI has zigzagged its way up making higher highs until just recently in early November it seems to have broken out of its trend when on 12 November 2021 it stood at 66.17 percent.

Let’s remember what that means as it is easy to forget. That means that 66.17 percent of the roughly 2,800 stocks listed on the NYSE are on point and figure buy signals.

Here is an explanation of point and figure buy and sell signals.

So what happened during the first two weeks of November to the three indexes we have been checking? Well, that is interesting, they all pulled back slightly.

Conclusions so far

So far, the major market indexes have been mostly pushing higher throughout 2021 while market breadth was weakening. Then just very recently breadth has returned while the major indexes pulled back a little.

What has been happening recently that could be linked?

Well, inflation has ripped ahead of where the powers-that-be said it should be, and the US Congress passed the new infrastructure bill while supply chain woes continue. That probably adds up to some sector rotation.

By the way, a few months back we were saying that inflation was likely to rise too many economists and institutions were in denial.

Select a sector

Now that we have established that the general direction of the market continues to be up, our next task is to target an industry sector. It makes the most sense in an up-trending market to look for funds or stocks in strong sectors.

One way to do this is to look at how sectors have been performing relative to each other over recent months. Here is a comparison of the eleven sector-ETFs that make up the Standard and Poor’s 500 Index. We are looking at the period from the beginning of August 2021 to 12 November 2021.

This article explains the industry sectors and ETFs we can use to track them.

⁹⁾Source: Stockcharts.com

From this chart, it does look as if there was some reshuffling between the sectors late in September. From late September onward the stronger sectors have been energy, consumer discretionary, and materials.

Let’s assume we were looking at the consumer discretionary sector. The automobile industry is part of that sector, so let’s take a look at the Ford Motor Company.

Let’s look at Ford

On 27 October 2021, this was the chart going back six months to May 2021.

¹⁰⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

This is looking like a classic cup and handle formation. True, ideally the base would have taken longer to form as this one is only about four months old. But it exhibits many of the right attributes.

The trading volume is lowest on the lowest levels in the base. The trading volume increases on up-days. On 27 October 2021, it does look as if a handle has formed.

Of course, we all know that Ford has been around for a long time so there will be plenty more price history and probably many institutions and investors who have held positions in the stock for many years. So we would expect that levels of support and resistance from years ago may still apply.

But just to be sure let’s take a look at more Ford price history.

¹¹⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

The area shaded in light blue is the more recent 6-month period we have been looking at. Just with respect to the last five years, the stock made a high around March 2021 after trading mostly sideways and a little down since the beginning of 2017 at least.

This confirms that we may indeed be looking at a cup and handle formation having built a base between June and late October 2021. Looking again at the period of interest we can add a 10 day moving average on the price chart.

¹²⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

There is a warning sign that this may not be a cup and handle forming. The last candle of what we might think could be the handle closes below the 10-day moving average. Nevertheless, if we assume this could be a cup and handle we notice that the bottom of the base was $12.57 and the lip was at $16.55. So the base to the lip of the cup is $3.98.

This suggests that if the price were to break above the last high, which was actually $16.55 we can expect that it might meet resistance again $3.98 above that i.e. at $20.53.

Maybe there aren’t enough positive signals to jump on board here. Personally, if I did have a position in Ford at this point I would probably have stuck with it. If I didn’t have a position I would have waited to see the price move to close above $16.55 on strong volume.

Let’s see what happened between 27 October and 12 November.

¹³⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

I know, this is wisdom in hindsight. But this does show how accurate technical analysis can be. The price did move up on strong volume and in fact, opened at $20.51 on 9 November 2021 and formed a hanging man candle. A hanging man is a classic bearish reversal candle.

If we had got in after it gapped up on 28 October we should have been able to enter at $17.

Once we saw that hanging man on 9 November, that would have been the time to exit. It is reasonable to assume we could exit at around $20. That would have been a 17 percent gain in eight trading days if we had traded the stock.

If we had been confident of a price move, we could have entered an out-the-money call option. To give it a bit of time for a price move to occur, it would make sense to go out to January 2022 expiration. A $20 January 2022 call option in Ford cost just under $0.50 on 28 October when the price was under $17. On 9 November if we had closed the position with the stock price at $20, the option would be worth $1.50. That would have been a gain of 200% in eight trading days.

One from the energy sector

Calumet Specialty Products Partners LP is a $1 billion company that makes specialty oil products. So it is a small-cap company in the energy sector which is a sector that has seen a lot of action in 2021. This is what its stock price has been doing from mid-April to 12 November 2021.

¹⁴⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

There are a few things we can observe here. Let’s add some areas of obvious price support and resistance.

¹⁵⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

As we can see the stock has been on a significant run since it broke above $6.50 on 15 June and then after meeting resistance at $7.38 it broke through again on 8 September. Then in early October, it moved higher breaking above $8.

We’ve also added a 20-day moving average, or MA for short. We can see that for some of the time the 20-day MA acts as resistance for some of the time and support at other times. But then in early October, the price broke away from the 20-day MA.

Right now the price is up at $14 and seems to be heading into new territory. The question we are going to want to ask is where could it go from here?

If there is one very positive trait in this chart it is that when the price breaks through what looks like resistance it does so on dramatically higher volume. When we see this sort of periodic spikes in volume on up days, it is very likely that institutions are buying and accumulating.

So what do we see if we look further back to see earlier price action and where support and resistance are likely to be. Let’s look at two years of price movement, from November 2019 to November 2021. Again we’ve shaded the shorter 6-month period we were looking at earlier in light blue.

¹⁶⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

We see a similar pattern repeating. The price seems to trend in gradually rising channels. Where the price previously found resistance once it breaks through it later finds support at the same level and then moves up into a new channel.

But still, it isn’t easy to see where the price might go. Let’s see what the price from the last five years looks like.
¹⁷⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

There does seem to be some price congestion around the $6.80 and $7.60 levels. But it isn’t necessarily very convincing.

So let’s see if 10-years of price movement is more revealing.

¹⁸⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

Of course the further we go back in time the less likely support and resistance from ten years ago is going to impact the current price target.

We should sound a loud note of caution. The further we go back in time the more probable the company could have undergone some fundamental restructuring. If we do want to draw inferences from much earlier price history, we should check whether there were any significant acquisitions or divestment of operations. We should only be drawing inferences from past price action if that comes from a time when the company was more or less running the same operation.

Nevertheless, what we see here, assuming that it is still broadly speaking the same operation, tells us that this stock could easily get to $20 or $25. It may take a few months or more to get there but that kind of level does seem to be on the cards.

And now the finance sector

The Bank of America Corporation is a fairly well-known company. Its market capitalization of $370 billion puts it firmly in the large-cap category. Let’s look at the price and trading volume over the last six months.

¹⁹⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

First, we drew some obvious levels of price support and resistance. We can clearly see the price was in a down-trending channel from May until around mid-July. Then the price was range-bound until it broke above a resistance level of $43 on 27 September. Then the price moves in an up-trending channel.

Not all the signals are good though.

Most noticeable is that volume drops off on the price rises, indicating that they are not really validated. Also, there is heavy volume on some significant down-days. Also very telling in the heavy volume on 14 July with a doji with long lower and upper wicks. Indeed there are many trading days that have small-bodied candles with larger upper and lower wicks. That signals uncertainty over the price direction.

All this suggests that the upward price trend that was established in late September isn’t very strong.

The conclusion we can draw from looking at Bank of America’s charts is that its recent move higher is not being sustained. There probably isn’t a convincing case for a strong move from here. Let’s see if more can be learned when we look at some history.

First for the last two years.

²⁰⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

We can see that it took the stock until March 2021 to recover all the losses from the COVID low of a year earlier. That is in contrast to the main indexes and most stocks that recovered by about June 2020. That shouldn’t come as a big surprise. The COVID pandemic has affected market sectors quite differently.

Here is an article that examines the impact of the COVID pandemic on financial markets.

Does five years of price history tell us any more?

²¹⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

Here we can see that from the beginning of 2018 to late 2019 the price was more or less range-bound. So let’s see if ten years of price history tells us more.

²²⁾Source: Yahoo finance, chart by Badinvestmentsadvice.com

If anything you could argue this shows the potential value of long-term investing in solid blue-chip companies. A long-term investor who bought shares in Bank of America Corporation in late 2011 could get in at $5 or less. Ten years later that position would have increased by a multiple of eight times to $40 a share.

The best way to use charts for stock trading

The best way to use charts for stock trading is to use them. I know, that is another trite comment but there is a simple truth here. The best way to use charts is to practice using charts.

There is no magic formula. You learn by practice and the more you use them the more you will see patterns and formations building.

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Questions and answers

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Q. Which chart style is best for trading?

A. Most traders find that candlestick charts are the best and easiest to read price movement.

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Q. What charts do professional traders use?

A. Professional traders typically use candlestick charts for short-term trades. They will also use point and figure charts and line charts to look at long-term trends.

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Q. Which technique is best for trading?

A. The best technique for trading is the one that suits your temperament, risk appetite and risk tolerance. Day trading sounds cool but you will find yourself stuck starting at a screen all day while the markets are open. Swing trading is less stressful than day trading. Position trading will tend to have you holding positions for longer.

The best trading technique is the one that lets you sleep at night.

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Single-page summary

Here is a single-page PDF summary of charting methods for stock trading.

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Disclaimer: I am not a financial professional. All the information on this website and in this article is for information purposes only and should not be taken as personalized investment advice, good or bad. You should check with your financial advisor before making any investment decisions to ensure they are suitable for you.

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Affiliate Disclosure: This article contains affiliate links. If you click on a link and buy something, I may receive a commission. You will pay no more so please go ahead and feel free to make a purchase. Thank you