Introduction to Chart Reading

Two opposing views on chart reading dominate the trading world and the public in general. Many people think that price charts are just fancy presentations of historical price data that has no real analytical value. Others take chart reading seriously think that it is all they need to figure out the near future of the markets they are studying.

My take on this subject is that charts are probably one of the best tools anyone can get in analyzing a market. The reason is simple. Historical data accurately represented in the chart tells the history of price changes as is, without all these false information like bogus financial statements, financial reports with fancy accounting tricks applied, etc.

Charts are not perfect. They do not contain all the information we would like to have in analyzing a market properly.

Since it is not a perfect world, we have to compromise and utilize what we can gain access to, don’t we?

Those who try to master the skill of chart reading often find it confusing in reading charts. Reading books after books on technical analysis, with all these indicators, charting styles, etc. simply make things worse. Tons of websites listed all kinds of technical analysis indicators, chart patterns with their definitions. But no one really willing to produce a concise guide on the subject.

So here it is – a concise summary of what I think that is important in chart reading.

Key Things to Remember

To keep things simple, here is a list of things to remember (in no specific order) –

• Read a chart from left to right (for those charts that have a time axis of course)
• Know the specifications of the symbol you are reading off the chart
• If you are learning to read charts, do not put indicators on the chart until you are more familiar with the basics
• Do not focus on the swing high and swing low that are easily pick out from the chart visually. They are important but the story of the chart comes from the bar to bar struggle among the players
• Price movements do not always form meaningful patterns
• In normal situation, continuation of current trend is more likely than a change in trend
• Price looks weak does not translate to a sell setup and vice versa
• Overall context of the chart is more important than price actions in an area that is not of interest to most players

There is Nothing to Interpret If You Know Nothing About Basic Chart Patterns

When you read a chart, it is useless to just stare at it and making subjective opinions.

To properly read a chart, you need to first build up your knowledge in basic chart patterns. I am not talking about simply recognizing these patterns that many technical analysis books leading you to believe. I am talking about knowing these patterns and what their exact implications are.

As an analogy, casual chart reading is like a normal person who can tell the difference of someone being sick because of certain symptoms like having a fever. Comparing that to someone proficient in chart reading is like an experienced doctor who know what else to check for after the obvious symptoms are identified, so that he can narrow down the kind of sickness the patient is having.

By having a solid foundation in chart reading first, then adding additional analysis on top will refine your skill further as oppose to confusing you. In short, build your chart reading skill to be as objective (scientific) as possible with emphasis on causation effects.

Importance of Internalizing (or Automating) Your Analysis

When you are trading in real-time, there is no time to question yourself if a particular section of the chart is showing the pattern you think you recognize. You need to internalize the recognition process. What you need from the pattern recognition is not just a bullish or bearish simplistic bias, but complete bias potential including where prices will likely travel to and if possible, the duration of time that this projection will take to materialize.

Do remember that it is possible that more than one chart patterns could be forming at the same time on the same part of a chart. If the different potential patterns converge to similar potential outcomes, it is likely you have a higher probability of those outcomes turning into reality. If the different patterns diverge into drastically different potential outcomes, that tells you the market is entering a decision making period (a critical moment), where the future price moves will greatly depends on the way how the current situation turns out.

Let the Chart Tells You the Story, Not the Other Way Around

Using charts to make your trading decision means you interpret the charts by using the chart patterns, analytic formations, etc. that you recognize to reduce the potential outcomes of the market you are trading into manageable scenarios.

Only when you get to a point where the manageable scenarios are producing actionable conditions then should you commit into a trade.

On the other hand, when you are already in a position, information you gathered from the chart should be used as a health check tool where you need to know in what condition should you bail out of your current position. A common mistake made by traders when they have open positions is that they keep looking for confirmation signs from the charts to support holding onto the current position. That means they are no longer letting the charts telling them the story.

Some traders when they are daytrading like to keep a marginally profitable position on with stop loss under the condition that they can no longer recognize or interpret the potential scenarios. When you lose grip of what may happen next in the market or that you do not have any idea what should be done next under various possible scenarios, it is time to fold the position.

Unlike long term trading, time is your enemy in daytrading and that keeping a position on with stop loss in place with no bias to lean on simply translate to this blunt fact – you are at least as likely to take a loss on the trade as being profitable. By putting it this way, does it make sense now to close the position and jump back in again when you get a better read of the market?

Beyond the Basics

Once you have a handle on basic chart patterns and being able to interpret a chart properly, you have several choices in improving your chart reading skill. First, you can explore further into more complex chart patterns to enrich your basic toolset. Second, you can add indicators and other data into your charts and learn to incorporate them into your decision making. Third, you can look into concepts like price structures (e.g. market profile and STOPD) and breadth analysis to further enhance your precisions in market timing.

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