One of the essential tools of the modern investor is the availability of charts and visual indicators to track the price movement of the financial instrument or listed company that you have an interest in. Eventually you will have to learn how to read price charts if you are to become completely versed in the language of investing. Charts add an extra and essential dimension of knowledge to the all-important buying process and they also help you sell for a better profit level. They can give you a thousand words of advice in an instant. They demonstrate, in no uncertain terms where the company or market has come from over the last few minutes, days, months years or decades. They also give you a tantalising hint of where a company’s price is heading in the near to medium term future future.
At first, a price chart can look like a music score to the musically illiterate, but, with time, they can be easily mastered. With all the bells and whistles of modern charting software you can sometimes be forgiven for thinking you have to be a genius to work with charts. This chapter is designed to cut through all the rubbish, hyperbole, myth and fear to give you a simple and useful understanding of charts. The essence of charting is the visual insight they give you as to what is going on inside the minds of all active investors in that company. The combined buying and selling of every market participant creates a chart by their collective actions. People’s actions are driven by their own psychology and beliefs. In the case of charts this psychology consists of three major elements: fear of loss, anticipation of gain which is greed, and a powerful memory of the price paid for their part of the company. These three elements put together will drive people to exhibit behaviours that are often very similar. As humans we respond to stimuli in similar ways, hence the creation of patterns in charts that can be predictive in other charts at a later date. Once you can understand these patterns you can use them for profit.
SOME WARNINGS BEFORE WE START
First, price charts can become addictive! Be very careful not to allow the parallel universe of charts to suck you through a worm hole and distort your belief in their usefulness. To the technically and visually gifted of us, charting can be dangerous as they cater to your unique natural gifts. You could end up so absorbed by the mathematics and patterns that you lose interest in the underlying fundamental story that take place in the real universe. If you allow this to happen you will rob yourself of untold dollars in investment profit, and you are reading this precisely so that you will not make this mistake!
Second, charts are very good for telling you when to buy in investment, but they are not very useful for telling you what to buy. Only your own hard nosed detective work will help you know what company is best to purchase at any given time. I call this digging into the avalanche of news, propaganda and informational static “fundamental research and bloody hard work”. After doing this research and finding your “once in a lifetime” company, you must decide if it is trending up, down or sideways. You need to know if it is undervalued or overpriced. You need to know if it is the right or wrong time to buy. Just as you would wait for your chosen new car to come on sale, so you should wait for your chosen investment to come on special. Unfortunately most of use get excited and have to have the purchase take place soon after we find the gem of a company just in case we miss out. The company chart will sometimes pour cold water on your enthusiasm.
Third, whatever you do, please don’t pay for charts! There are literally thousands of sales people out there who would love to sell you their latest proprietary software for reading financial charts. Each of them is going to have a secret weapon for making money. If only you spend a few hundred dollars on their proven, supercharged, high performance money-making machine, you will be set for life in a week! On top of the sales price, their product will often require live feed, at a price. These charts may be of some use to a professional analyst but in this era of the internet you should never have to pay money for the amount of information you need as a beginning investor. All you need to know and access is on the net for free.
Fourth, in my experience individual charts can only tell you the past. They can not tell you a great deal about the future apart form a short timeframe of up to six months at the absolute most. The further out you look into the future, the less reliable charts become and the more you will have to rely on trends in the industry, the overall market sector direction, supply-demand equations, the domestic economic direction and global macro economic developments, especially interest rate movements. All investment markets are forward looking by nature so charts are the tool of choice for those with a very short investment time frame, namely the futures, derivative and day traders. The big money is always made by looking at the longer time-frame because time is your friend. As an investor I have leant the hard way to look further into the future and not react to knee jerk reactions on a chart that dissipate over the next month or so.
Fifth, we all see what we want to see in a chart. Each of us brings our subjective personal experiences and beliefs to the art of interpreting charts. We all live in a slightly different universe, and will therefore see slightly different messages in a chart. It is not quite like reading tea leaves, but it is an issue you must be aware of and guard against. If wee feel bullish about a company then we will bring to the chart some of that enthusiasm. This will create a type of rose coloured blindness that restricts us from seeing some of the patterns that might otherwise be obvious. Alternatively, when everybody around us is uptight about the market, we will probably view our precious charts with a set of dark, pessimistic glasses.
Finally, charts create patterns because humans behave in predictable ways as new information comes in and as they weigh up their previous decisions. However, chart patterns are only a guide to the future. They do not guarantee the future direction of the price. They are at times very reliable and should be treated with respect, but they are always subject to incoming information. They are never 100% reliable, especially in this era of massive central bank intervention in markets. If they were, everyone would use them all the time and there would be no market. To have a market you have to have people with the opposite present needs and view of the future, that is, buyers and sellers.
Having been warned of the limitations of investment charts, it is time now to look at some of the clever signals and hints they can give you that edge on when to buy, when to sell and an understanding of where your company is heading in the short term.
Markets do not move in straight lines, they move in pulses as the general consensus moves from “it’s a bargain” to “it’s a rip off’. These pulses look like the teeth on a carpenters saw, right up to a rugged mountain range. Two steps one way and one step back is the usual way things happen in markets. As a rule, when you start to see these pulses diminish in size during a market advance or decline, it usually means a change is coming. It is a bit like hitting a golf ball. It might be rising to begin with but soon the energy will dissipate and it will begin to fall. Likewise, if you see these pulses start to increase in size it suggests the market is gathering momentum.
Make sure you always keep an eye on the angle of price movement in charts. This is the most obvious thing to look for when charting but it is so easily missed. Angles will often become fixed until new information reaches the market. Prices moving at a fixed angle are what we call a trend channel. When these angles, or channels, suddenly change then it is a sign of things to come. The typical large movement over many months will often have two distinct angles of movement, one steep and one not so steep. When rising, a market will rise steeply, but then a second flatter phase will kick in as momentum is waning. In a bear market the initial fall will often be shallow and then a second phase of steeply falling prices kicks in. These patterns come up regularly in large markets but are less common in smaller individual companies.
In addition, many companies will make significant moves at the end and beginning of months as professional managers are rounding out their books or taking up new positions. As you slide down the pecking order of companies, this effect is less pronounced. In the days immediately before and after public holidays, you will likewise see unusual strength. The most pronounced of these is called “The Christmas effect”. People come back to the office after the holidays in a good mood, and the charts move accordingly. Finally, there are strong months and weak months. Generally, the middle of the year is weak and the end/beginning of the year is strong. “Sell in May and go away”, they say in America. I wish I had learned this lesson much earlier than I did. Watch out for all these patterns in the charts you keep track of.
Generally, the stock market rises 70% of the time and falls 30% of the time. Individual companies will rise more gently and for longer periods of time than they will fall. Humans will gingerly bid up a price, grudgingly paying more for the company. When they fall they will collapse much faster and your emotions will feel every part of the roller coaster descent if you are financially committed. Look at any chart and you will see this phenomenon. When in fear mode, investors will jump like rats from a sinking ship.
Time is also very important to the reading of charts. W.D Gann was a legendary investor in America in the early part of the 20th Century. He discovered that prices couldn’t move until the time is right. He found that time can be measured and used this insight to predict future turning points. Time acts as an invisible chart sitting behind the price chart. Humans act according to seasons, phases of the moon, political calendars, the movement of the sun and all sorts of other mass influences. These become predictive. A study of time is well beyond the scope of this short introduction but it is mentioned as a reminder that we humans are not fully autonomous. We are largely controlled by outside forces and behave accordingly. Charts will often tell you messages about these outside influences. The take home message is that, when you have done the right thing, time should be your friend.
I have learned over time that a good chart needs a deep market. Thinly traded micro-cap companies create bad charts that whipsaw and produce unreliable patterns. The deeper the market for that company then the more reliable the chart becomes. I have personally moved the price for a small company through my buying and selling actions. Always remember too that weak money creates the first few hours of the daily bar on a chart, while the smart money creates that which happens after lunch. This is especially true on a Monday and a Friday. Fools rush in at the open. It is best to wait two hours before buying. If a chart finishes on its high, it is a sign that people believe in a rosy tomorrow.
There are many different ways to construct a chart. The most common is the line chart, which tracks the closing price only. A better chart to follow is the bar chart, which tells you where the first trade of the day occurred, the range of trades during the day, and where the last trade occurred. The information in these charts is many times greater than the line chart. The two charts below show you the difference. There are other methods of constructing charts such as the candlestick method invented by the Japanese 400 years ago. For beginners though, the bar chart is all you need to master.
When considering the movement of stock prices you must always think of the price as a set of weighing scales. These scales weigh all the sentiment and knowledge of all market participants at a given time and it will decide, with brute force, who is right. When sellers are equally pitted against buyers, there is balance in the scales, and when one tribe over-runs the other, the scales tip to either end. The price chart is simply a set of value scales, that is constantly tipping from undervalued, to balance, to overvalued and back again. Keep this in mind when reading everything that comes next. Your mission, if you choose to accept it, is to always buy when the scale is flashing to you that it is undervalued.
1. Higher Highs and Higher Lows:
The most basic way to use a chart is to look for the general price direction of the company or investment. If the company chart is making a series of higher highs and higher lows over several months, then it is an established up-trend, and, all other things being equal, it would be a buy. A series of higher highs and higher lows simply means that the company story is spreading out there into the market and more and more investors like what they read and see. The risks the company faces are shrinking, while the probability that it will reach its financial goals is increasing. New investors see greater potential to profit from the emerging story and are willing to pay the premium that earlier, more risky investors didn’t have to pay.
Increasing price should be accompanied by increased volume as more people begin to actively trade in and out of the company. Increasing volume is what drives price higher. It is the cause of price movements. If a chart rises on little volume then it is a dangerous sign. Weak and ignorant buyers are foolishly bidding up the price. Sooner or later, strong selling will kick in and wipe out their profits plus some of their capital. The steepening slope of the trend can often give you a hint of when the price has moved ahead of itself. By simply looking at the angle of slope you can gather information about what most investors are thinking. When the angle of decline flattens for a few weeks or months, it could signal a buying opportunity. When it steepens when in an uptrend, it may not be a good time to get in.
You would be amazed how many times people, including myself, have disobeyed this most fundamental of rules, to follow the trend. The trend is your friend but human nature tries to out-guess the market and pick a trend change right at the bottom or top. Let some one else take that huge risk. Just go with the flow, but enter early enough so as not to get caught near the top or enter when there is a minor pullback to the bottom of the trend channel.
In the chart below, which was once one of my investment companies, gives you an example of a company making higher highs and higher lows. I bought it in July at the 65c level and had to wait three months before coming out of the red! Finally, the rest of the market began to see what I had already glimpsed through my fundamental research. Note the increasing volume as price rises. The company fell back after this chart was printed because the angle of ascent rose too steeply.
This is an extension of the above principle of buying the trend. For those who have the extra fortitude and who love a bargain, there is the opportunity to buy into an upward moving stock price when it comes down to the lower part of its trend channel. This stacks potential buyers together and there are fewer willing sellers. There will usually have been less trading volume in the slide down to the lower part of the trend channel and the support levels can often be at significant round numbers. Humans love round numbers and will often create resistance levels on or near them. The longer the trend-channel, the stronger the support at the bottom of the channel and the more reliably you can purchase in this zone.
The danger in this approach is that you are going against the crowd. There is a herd instinct in all of us that doesn’t want to take a risk that the crowd isn’t. We wonder why the other investors are selling off the company. Could they know something you don’t know? Is this the end of the larger trend? If the fundamentals haven’t changed then it is a fair bet the company just ran ahead of those fundamentals by a little and is taking a few weeks breather before a new round of enthusiasm grips the price.
One of the hardest things to do is to buy on these dips as the price could immediately head lower after purchase. Wait until you see signs that selling is exhausting. Some of the signs are the time-frame of the correction which is usually 2-4 weeks in an uptrend, a move on the relative strength indicator, or RSI, to a low of around 20-30, shrinking volume in the decline and no change in the company story or the market it operates in.
Now look at the above chart again. From September to February it rose slowly in a trend channel. You can now see that there were good buying opportunities on pullbacks to the 65c, 70c and 80c levels. These prices provided support for the company. And were a good entry point after observing the price sitting at those levels for a few weeks.
3. Tops Become Bottoms and Bottoms Become Tops.
There is a psychology and mass-market mindset behind every chart pattern and none more so than the fact that previous resistance levels become new support levels, and vice versa. The market truth that resistance to price advance later becomes support for prices retreating from a higher level, is one of those iron clad rules you do not want to mess with. When sellers are eager to unload at a particular level and selling is eventually worn out, the stock price will spurt through the resistance level, march upward and eventually find a new resistance level where a new crop of sellers are keen to take their profits. A break out from these resistance levels is a good place to buy because there will be few sellers around for the next little while.
When the market turns down from a new high it will often fall back to an old zone of resistance. People who sold back then, have learned that they missed the boat and will be keen to buy back in at a level similar to where they sold. This will put a floor under the price as it gathers momentum for its next advance.
Sometimes you have bought stocks and soon regrettably realise they are trending down instead of up, because you didn’t look at a chart when you bought them! The same psychology can be used to sell out at a slightly higher price. Wait until the selling is exhausted and the price will rise on lower volume to near the last floor level. Sell into these highs, lick your wounds and keep you capital to fight another day. Don’t try for an extra few cents in these situations because they won’t last long. Only hold out for a few extra cents when you are selling in a rising market. I will spell out the rules for selling in another chapter dedicated purely to that topic.
The chart below shows you how tops become bottoms. Between May and August, the price of gold kept hitting resistance around the $1630 level, but the lows were rising, signalling strength. This is called a rising wedge. Breakouts from these patterns are usually strong and this one certainly was! The rally went straight up to a major resistance level at $1,800. By January it had sunk right back down to this level where a new wave of buyers emerged signalling a new rally to challenge the $1,800 level was about to begin.
Now look again at the first chart above on Medusa again and you will see another layer of information. The 70c level gave us resistance but later became support. Then the 80-85c level created resistance which also later became support.
3. Triangles and Breakouts
It is often observed that a company’s stock price seems to bounce off a ceiling. This is an extension of the resistance principle mentioned above. However, in this case the resistance stays in place for quite some time and is generally flat. One or more entities with lots of stock in the company are quietly unloading them and the instructions are to sell into any strength as it reaches a certain level. If the lows on the chart are trending up at the same time as the flat “table top” develops, we have what is called an ascending triangle, as can be seen above. The buyers are getting more confident that this is a good company to be involved with. The descending triangle is a fairly reliable indicator that the price will eventually start to move up quickly when the large sellers have finally run out of ammunition. The longer a stock bounces off a key resistance level the bigger the breakout when it finally comes. Once again, the resistance often comes at significant round numbers. After a break out there will often be a rapid advance to a new level of equilibrium and resistance.
A breakout is often followed by a news event that justifies the breakout and propels it higher. People buy on anticipation of good news coming through and will ramp up their positions ahead of time. When the news comes in as anticipated, it will often have little effect on the price. The news is treated as simply confirmation that people have made the right decision and they will hold for an extended time-frame.
The breakout from resistance will often be the same size as the hight of the left side of the price chart where it first rose up to the resistance line. This is usually a strong rise and the entire process of bumping up against resistance must be seen as a continuation of a rising trend. Instead of a nice orderly rising trend, something happened earlier to cause the price to soar and become overvalued. Time is then needed to restore equilibrium so the price goes flat for an extended time. When the next breakout does come, it should be confirmed with increased volume. Once the selling has been absorbed, the trend can continue.
These breakouts from resistance levels are one of the most reliable patterns you will see on charts. They occur in rising and falling markets. As time goes on you will learn to see them clearly and buy into them wisely. In a falling market the opposite happens; support levels, often at round figures, create a floor under the price and hold it there as a keen buyer enters the market with deep pockets. Once their buying is absorbed, the decline continues and prices can break very quickly to the downside, much to the disgust of that rich recent buyer! When the price finally does bounce, our frustrated friend becomes a seller and creates a new ceiling on the price.
The chart of Medusa mining, shown above, had a tentative breakout above the 85c level at the end of January. Someone very enthusiastic decided to pay what the market asked. Other buyers then hesitated to pay the higher prices so the buying came back to the 80c level. After this event, all sellers were gone and the buyers flooded in with such enthusiasm that they fell over themselves to get into the company. They even left a gap in the chart, a rare event that usually heralds the final run up in a rising trend if it happens after a season of steadily rising prices. Ascending and descending gaps usually get filled after enthusiasm and pessimism finally dissipate. However, the one exception to the rule is that gaps formed at the beginning of a rally out of a bear market are not often filled. All of the price action in Medusa Mining was happening on the back of no announcements from Medusa Mining! However, all knowledgeable investors were already well aware that Medusa, a mining company, was getting very close to commencing initial production at the 40,000 oz level, with a ramp up to 100,000 oz by the end of 2007. They concluded that the company was fundamentally undervalued and bought accordingly.
The following two patterns are simply variations on the concept of the ascending or descending triangle. A flag is a downward sloping formation that creates a parallel trend channel running in the opposite direction to the main trend and lasts for up to the usual 2-4 weeks. A pennant is like a flag but becomes pointed as time progresses. Think of a pennant as a downward sloping triangle and the flag as a downward sloping resistance level. This will make them easier to understand. These two formations are also continuation patterns and mark out a period of consolidation before the larger trend reasserts itself. They are a pause in the direction of the stock price, created from the same over-enthusiastic investors who bid the price up to the resistance levels mentioned above. The flag and pennant are simply resistance levels that soften as time progresses. They appear quite regularly and should give you heart if you are already invested as they usually mean the trend will take off again soon. However, because they are weaker than a straight ascending triangle, I never use them for trading. As per the rules above, volume must increase as the prices breaks out of the flag or pennant. Flags and pennants, like ascending triangles, usually appear half way through a run.
To finish off this section I am going to give a quick summary of the signs to look for when wondering if a bull market trend will continue. Most healthy rising markets have large upward or downward market pulses on healthy volume. The more vertical the upward pulse the more likely the move is to continue. The more vertical the downward pulse the less likely the trend is to continue. The 50 day moving average should basically be moving in a straight line. Prices should be bouncing off the lower trend channel in a bull market but allow for minor breaks of the trend channel because the professionals like to run peoples stop-loss orders at these critical levels. If the market breaks the top of the trend channel this is a good sign. The MACD indicator should not go into negative readings. Triangle, flag or pennant formations usually occur at 50% levels through the bull market. Declines should take place on lower volume than rising pulses. When the fear levels are declining, which you will find in the VIX indicator, the market will continue to advance.
1. Key Reversal Days
These typically happen when the market opens in an extremely bullish mood, after a very bullish few days or weeks when prices have been moving rapidly. Finally the long awaited announcement comes out. Buyers fall over themselves to get the stock first thing in the morning. However, they are foolishly buying on news that has already been factored into the price. After they have entered the market there are no more buyers left, wiser and more experienced investors start to unload at a substantial profit. There is a sharp fall on high volume for the rest of the day. Profit takers and short term traders are off to the pub! By the end of the day, the price is well below the morning open and volume is through the roof. Reverse the whole scenario for a reversal day at the end of a bear market.
Key reversal days are highly emotional and will usually mark the end of a trend, at least for the next few weeks or months. If the company or financial instrument is solid, with a great story unfolding, then an ascending triangle may develop, but not without first experiencing a significant reaction.
Key reversal days are not common. In fact they are quite rare, so when they do occur, they are a very reliable sign of a change in sentiment. They occur much more frequently at the end of a bear trend than at the top of a bullish trend. This is because markets climb the stairs when rising but take the elevator back down when falling! After weeks of relentless selling, some negative piece of market news will cause frustrated and nervous owners of the stocks to sell at any price. The price plunges in the morning on huge volume, only to recover beautifully in the afternoon to finish on its high, or near the open, on huge volume. The big boys have sniffed a bargain and started buying. Key reversal days are the only pattern that allows you to know the day to get in right at the bottom or out right at the top if they form at the top of a parabolic ascent.
The chart below is an update on the gold chart above and you can see clearly that a large reversal bar has just occurred on double the normal volume. This has occurred right at the bottom of a defined trend channel at an area of strong support created out of previous resistance. The reversal bar also comes in with the MACD, or Moving Average Convergence Divergence, indicator showing the market is oversold. The MACD is a very reliable and widely used jazzed-up version of a pair of moving averages. To top it all off, the reversal bar also comes at the end of a classic ABC pause in a major continuation trend. The chances of a major change in trend are now very high.
2. Cup & Handle Patterns
A cup and handle is a rounded bottom or top formation that takes several months or years to complete. They are often formed at the speed of a glacier moving and are so frustrating to be caught in! The price does not plunge into a frenzy of selling; it simply goes to sleep slowly on ever decreasing volume, over an extended period of time. The action is elsewhere. After its season of winter, the price slowly awakens to the prospect of better times ahead for the company.
Cup formations are unusual but are most common at the end of a bear market rather than the top of a bull market. They are a very reliable trading pattern simply because of their size and the time they take to form. As the cup takes shape, the volume will usually track the shape of the saucer, shrinking into the base and slowly rising on the right side of the chart as it emerges. If you have done your research and you believe the company is going to go places, then buy after the cup has completed its shape. Don’t try to guess the shape when only half complete, unless the fundamentals are telling you it is a great buy. Your buying can be relaxed, the company is not going anywhere in a hurry.
Because this formation is so reliable I am going to now give you a lot more detail on how they work. I am doing this for two reasons. First, I want to show you the sheer volume of information you can derive from a chart if you dig deep enough. Second, it will allow you to trade them with more confidence if you wish. So this is what to look for in a cup and handle formation:
Leading up to the left hand top of the cup there should be a strong and definite price rise of at least 30%. Trading volume and the RSI should also increase substantially in this lead up. These price movements are best if they are associated with a move up in the general market. The best cup and handle formations then occur when the market as a whole corrects for a few months in a bull market, or when a great company is growing and the market as a whole is very near the end of a bear market. Few cup and handle formations will work if a company forms one when the rest of the market is booming. It is a sign of weakness.
After the first top the decline should vary from 12% to 33% of the prior move, the shallower the better. The cup pattern is best if it lasts between two and twelve months. Most last from three to six months. The bottom of the cup should be U shaped. This will happen in most cases. This U wears out the last of the weak owners and takes the market’s attention away from this stock. It also allows a new group of strong owners to accumulate a large position in the company. The correction in a strong growth stock will usually be around two times the corresponding correction in the overall market. The best choice for trading will be the companies that correct less than others in their industry. A cup depth that is over two and a half times the whole market average decline has a high likelihood of failure at the final breakout. If there are large swings in price at the low of the cup then the pattern may fail as it is too much in the public eye. So it goes without saying that volume should be very low here as holders are unwilling to let go of their stocks. This volume drought should last for at least two weeks with very tight price movements.
Now this is what to look for in the handle. A cup without a handle usually has a high failure rate as they do not create the shake-out needed to neutralise sentiment, and the handle should take a few weeks to work through. It should have a downward drift, but only within the top half of the formation, any deeper and it is too weak. Look for handles to be a pennant, ascending triangle or flag formation. Volume should drop to very low levels as few are willing to sell. The right side of the cup represents a double top continuation formation. What you want is a small pullback off this top.
For traders, the final breakout is the best point to buy. It is the safest and most likely to see a large, quick price move. The entire cup and handle formation represents suppression of the natural upward trend so by the time you reach the breakout point there are literally no sellers left and buyers have to go to much higher prices to get in. Watch for large volume to confirm the breakout. Most buyers at the breakout point will be professionals that need to trade large volumes. Institutional support is vital for further price gains. The final breakout is the final proof that you are buying a quality company with a bright future and the chances of the price falling back below the breakout point are very low. But if they do you need to have a mental sell price already locked in at five percent below the breakout point. Finally, the price distance from the bottom to the top of the cup is often the same as the distance the price will move after the breakout. This represents the final sell point if trading.
3. Head and Shoulders Patterns
As the name implies, the shape of this pattern resembles the human head with its two shoulders. It is one of the more reliable reversal indicators, but by the time it is complete and trustworthy, the reversal move may be already half over. The left shoulder on the way up is a pause as sellers come out of the woods to greet the buyers. The trend resumes and is met with stiff resistance at a higher level. The sellers are so strong at this level that they completely overwhelm the buyers and the price falls away to the right shoulder. Buyers have one blast of enthusiasm but their ranks quickly thin. The price is then free to fall away off the right shoulder with increasing volume, marking a major change of trend. The reason for the two shoulders is simple. The market had a collective memory of the tussle that took place at the point of the left shoulder. It was a resistance level that was recently overcome. The battle at the right shoulder is to find out if resistance will become support or fail. Some investors know the company is worth more because they have just seen the price move higher, while some are convinced it is in danger because they are already in a losing position. Reverse head and shoulders pattern can also occur at the end of a bear market and will be the upside down reverse image of the topping pattern. Below are the two examples.
4. Double Tops and Bottoms
The double top and bottom is another reversal pattern and are very reliable if they create major termination points in a market. When a major top is made, buyers are beaten back by sellers. When buyers (or sellers in the case of a double bottom) have been beaten back twice there will be very few people left to push prices higher (or lower). There will be twice the sellers once the price retreats from the second peak and twice the buyers if it bounces off the second bottom.
A less common, but very reliable pattern is the triple top. In this instance there were enough new buyers to have a third attempt at pushing the price higher. When this fails or breaks to the upside, all hell will break loose, in a good sense. If you witness a double or triple bottom then you are witnessing the beginning of a very strong upward move in prices. As I write, the US$ gold price has created a triple top at $1,800. When this breaks in 2013 it will be a very big move up.
There are many other excellent charting indicators in use around the world, but they have less and less marginal value to the average investor as they look at more and more of them. Charting is useful in so much as it tells you the general direction for the next few days, weeks or months. It is a helpful skill for understanding when to buy and sell. However, your decision to buy a company should never be left to charts alone. I have only done this once in my stock market investing career. It occurred in 2006 when a well respected international chart expert announced that a junior Australian mining company was going to go places based on the chart. This expert had done no fundamental research on the company. Because this person had such a good reputation, I invested heavily on his advice. The chart below shows you what happened next. After seeing a brief profit evaporate into a small loss I waited for the price to lift and exited with a $6,000 profit in one fund and a $6,000 loss in another. I felt the fundamentals of the company were marginal and there was better fishing elsewhere. After I exited, the company plummeted to a quarter of my exit price. It was a salutary lesson in making sure I know the full story before trusting a chart. Here is the chart and you should be able to see immediately why I should not have gone anywhere near this company, it was in a downtrend. I bought in March 2006 and sold in early August, much to my relief! Please let this be a lesson I had to learn you don’t have to learn. That is the whole purpose of this book.
There are many places on the internet where you can learn the finer details of charting. A simple Google search will come up with many. I have found that www.stockcharts.com is as good as any. Simply click on the tag that says “Chart School” and you will be away. I would also recommend www.investopedia.com and you can access chart patterns through the “dictionary” tab. Finally there is the good old Australian Securities Exchange at www.asx.com.au and you can access charts through the “Prices & Research” tab. All the patterns taught in these sites are similar to what I have shown here but with their particular slant. You will learn from every site something unique. The important thing is to keep learning. Never assume you have arrived. The longer you invest the more you will see into the depths of a chart, and the more it will “sing to you like music does. Enjoy the song!