Financial Adviser: 5 Ways to Read Price Charts and Trading Patterns to Make Money in the Stock Market

Understanding how stock prices work is crucial for anyone interested in investing in the stock market. At the heart of stock prices lies the principle of supply and demand, which dictates how prices fluctuate based on market emotions.

In essence, stock prices are reflections of market emotions as determined by the balance of demand and supply for a particular stock. When there is more demand than supply, share prices tend to increase, while when there are more sellers than buyers, they tend to fall.

The factors influencing the demand and supply of stocks can be both rational and irrational. Rational factors include the financial performance of the company, its growth prospects, and the overall health of the economy. On the other hand, irrational factors include market sentiment, rumors, and even herd mentality.

For instance, during the peak of the interest rate last year, the PSE index fell to its lowest since pandemic at 5,700 level. Investors sold their stocks out of fear, believing that a further rise in inflation could bring the PSE index lower.

However, as soon as investors realized that the selling spree was overdone, share prices began to rally on bargain-hunting. With improving market sentiment, the PSE index recovered strongly towards the year-end, peaking at 7,046 during the first week of January 2023.

The PSE index has been on a downward trend the past three months, losing close to 500 points from its high this year at 6,500 level. Based on the stock chart, the PSE index is bound to test a key support at 6,300. Failure to hold could send the stock market falling back to 5,700.

Analyzing price patterns in stock charts assumes that what happened in the past can happen again in the future. Price patterns reflect how the market feels about the future of a stock, and they provide clues as to whether the demand for a stock is likely to increase or decrease.

One way to understand market emotions is to read stock charts carefully. By studying these charts, investors can spot trends and patterns that could help them time the buying and selling of stocks to maximize their profits.

However, it is important to note that stock prices are affected by a multitude of factors and that past performance is not always an accurate predictor of future performance.

Understanding how stock prices work is critical for anyone interested in investing in the stock market. By grasping the principles of supply and demand, and by analyzing price patterns in stock charts, investors can make informed decisions that could help them achieve their investment goals.

Here are five ways you can use stock charts to trade profitably in the stock market: 

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1| Identify changes in price patterns

In chart analysis, trend lines play a vital role in determining whether a stock is moving upward or downward. These lines are created by linking two or more past price points and extending them into the future. As long as the stock follows the trend line, the trend remains unchanged.

Trend lines also function as support and resistance levels. If a stock is on an uptrend, the trend line that connects the price points is known as the "support," while if it is on a downtrend, the trend line that connects the points above the price is referred to as the "resistance."

When a stock breaks through either the support or resistance line, a change in the trend is likely to occur. This shift in trend indicates a change in the supply and demand for the stock, which could result in a minor or major correction.

During the COVID-19 outbreak, the PSE Index broke a crucial support level at 6,800, leading to a shift in trend towards a downward bias. As a result, the market experienced a significant decline, with the PSE Index dropping to as low as 4,039.

Today, the PSE Index is at critical support at 5,700, assuming it fails to hold at 6,300 in the coming days. It is expected that the market will bounce from this support, but if global market sentiment continues to be negative, there is a strong possibility that the market may break this support.

A breakdown of the 5,700 support will signal a major downward trend, which could bring the PSE Index visiting its pandemic low at 4,039 in the months ahead.

On the other hand, if market confidence improves, a rally in the PSE index may limit its rise up to 6,700 resistance. If the market successfully breaks this target, the next resistance to overcome shall be 7,137, which was its peak this year.

2| Identify changes in trading volumes

The volume of trades can provide valuable insights about price movements. If a stock's price is increasing without an accompanying increase in trading volume, it could indicate that the uptrend may not be sustainable.

Similarly, if a stock's price is decreasing but the trading volume is not rising, it could suggest that the decline is not strong and that the stock may soon recover.

During the bullish market of 2017, the PSE Index experienced an upward trend with increasing trading volume, indicating a robust uptrend fueled by rising demand for stocks.

Although the market experienced corrections during this period, they were considered weak because they were not supported by higher trading volumes, which strengthened PSE Index’s recovery.

But today, the trading volume in the market over the past three months has been rising, supporting the fall in the PSE Index from its peak last January. This rising volume indicates strong selling pressure, which could bring drag the market lower in the coming weeks.

Studying the trading volume by looking at the momentum generated by rising and falling share turnovers can provide clues about the future direction of a stock's price.

3| Identify market overreactions through price gaps

Investors are known to have a tendency to overreact to sudden news or announcements that can impact stock movement, according to market psychology.

One indication of market overreaction is when a stock experiences a significant price gap at market opening due to a noteworthy event that occurred overnight and was not yet factored in by the market.

During the height of the lockdown, the PSE Index experienced several gap downs as the market panicked. The first occurred on March 9,2020, when the PSE Index opened 170 points lower and ultimately closed the day with a loss of 457 points.

Two days later, on March 11, another gap down event occurred as the PSE Index opened with a 101-point loss during the first minute of trading and closed with a loss of 616 points.

Although such a massive sell-off might be considered an overreaction in a normal market, during these stressful moments, the momentum from extreme panic selling was so strong that the PSE Index gapped down again on March 19 with a 659-point loss at the opening.

On that day, the PSE Index lost as much as 1,296 points in a single day before recovering slightly by the end of the trading day.

If you took advantage of the market’s overreaction that day by buying shares at its panic levels, you could have made a huge 77 percent return on your investment by end of 2020.

4| Identify oversold and overbought conditions

To determine whether a stock is overbought or oversold, price charts can be helpful. When a stock is oversold, buying it at a good support price can lead to a quick profit, as it is likely to recover soon.

Conversely, when a stock is overbought, it means that its price has risen too high compared to its recent levels, and a correction may be imminent.

If you are anticipating a correction, you can either take profits by selling your shares or position yourself to buy more at a lower price by identifying a good support price.

One way to identify overbought and oversold conditions is by using stock price indicators, which are calculated using historical prices in various formats. 

The Relative Strength Index (RSI) is a common indicator used to measure the strength of a stock's price movement. It is calculated using the stock’s past gains and losses over a given time period, typically 14 days.

The RSI indicator ranges from zero to 100 percent. If the RSI indicator goes above 70 percent, it means that the stock is in an overbought condition. On the other hand, if RSI indicator falls below 30 percent, it means that the stock is already oversold.  

When the PSE Index peaked at 7,137 in January this year, its RSI was already approaching the 70 percent, indicating its overbought condition, but when the RSI level fell to 32 percent in March as the PSE Index tested its 6,300 support, the market quickly recovered from its oversold condition.

Traders often use the RSI to identify potential buy or sell signals, as well as to confirm the strength of a trend.

However, it is important to note that the RSI is just one tool and should be used in conjunction with other technical indicators such as Stochastics, MACD and Momentum indicators, which are readily available in any online charting software.

To learn more about indicators and how you can use this in your trading strategy, it is recommended that you invest in a technical analysis course.

Many online brokers offer this for free to clients, but if you are serious about mastering these concepts, you can also get a certification course such as the Certified Technical Analyst (CTA) program offered by the Society of Technical Analysts Philippines.

5| Identify timely trading decisions

In stock market trading, there is no holy grail. Success in utilizing price charting requires discipline and commitment.

To identify potential trading opportunities, it's important to monitor price action daily and recognize early buying or selling signals. Timely trading is crucial for succeeding in price charting.

It's not necessary to trade constantly. Only trade when there's a good opportunity.

When investing, always consider your time horizon. If you're trading for short-term gain and your strategy fails, have the discipline to cut your losses unless you intend to make it a long-term investment.

Trading can be exciting for some people, but frequent trading can lead to losses due to accumulated trading costs.

There are hundreds of patterns and charting techniques available, but mastering a few that fit your investing style is sufficient.

If your techniques are no longer effective or you want to improve your skills, you can research and learn from experienced traders, or you can attend advanced courses.

Henry Ong, RFP, is an entrepreneur, financial planning advocate and business advisor. Email Henry for business advice hong@financialadviser.ph or follow him on Twitter @henryong888