The prior section on How To Buy Stocks focused on what stocks to buy. It covered stock lists and a stock screener to discover ideas, as well as stock ratings to evaluate your potential stock picks. In this section, we'll focus on when to buy stocks using stock charts and technical analysis; the optimal time for buying stocks.
Keeping in mind these other aspects of stock investing, let's focus on how to read stock charts and understand technical analysis.
When learning how to invest in stocks, stock charts can seem overly technical at first. Talk of moving averages, chart patterns, relative strength lines and other terms can scare off beginning investors. But put aside all the jargon of technical analysis to understand what stock charts really do. They tell you a story.
Stock charts simply give you a visual representation of changes in share price and trading volume. They cut through all the rumors, headlines, hype and fear. They paint an objective picture of what is really going on with the market and individual stocks.
Once you learn what to look for, you'll see that stock charts and technical analysis give you objective, fact-based insight into key questions that impact your stock investing strategies.
By the end of this section, you'll know the basics of how to use stock charts. You'll also see how to use technical analysis to make sense of the "story" the charts are telling. Once you've done that and also gone through the earlier sections, How To Buy Stocks and Stock Market Timing, you'll have a solid understanding of how and when to buy stocks. These approaches to technical analysis will also help you learn when to sell stocks.
Some services make stock charts overly complex, adding too much non-essential information. IBD charts are clean and simple, featuring all the key indicators you need to answer the questions mentioned above to understand the "story" the chart is telling. Our stock charts are also color-coded to make it easier to spot daily and weekly moves, as well as spot trends.
Here's a quick look at the key elements to look for in a stock chart. (The discussion below focuses on the daily and weekly charts, but the same concepts apply to monthly or intraday stock charts.)
Daily Vs. Weekly Stock Charts: Use Both
Investors new to stock investing may wonder if they should use daily or weekly stock charts. The short answer is use both.
Weekly charts help smooth out daily price fluctuations, making it easier to identify longer-term trends in both the market indexes and individual stocks. Daily charts helps you spot specific buy points, buy zones and sell signals.
Using the daily and weekly stock charts together helps distinguish between normal price changes and a true shift in trend. That will prove valuable when it comes to both pinpointing the best time to buy — and deciding if it's time to sell or just sit tight.
Follow The Funds: Track Price And Volume With Stock Charts
What is the most immediate and effective way to monitor demand in the indexes and individual stocks? Track price and volume fluctuations in both daily and weekly stock charts.
You can also measure how heavily stocks are being bought or sold with stock ratings and features, such as the Accumulation/Distribution Rating and the up/down volume ratio. But stock charts provide the most timely way to gauge buying demand — or a lack thereof — by mutual funds and other large investors that drive the market.
Just click inside the price area on a daily or weekly chart to pull up a data box like the one shown in the screenshot below. You'll find the latest price and volume information, including:
- High and low price for day or week selected
- Most recent price
- Price change for the day or week selected (in dollars and percentage)
- Volume (i.e./ number of shares traded) for the day or week selected
- Volume % Change: Shows how far above or below average the volume is for the day or week selected
Tracking price and volume in tandem with each other gives unbiased, opinion-free insight into the behavior of the market and individual stocks. As mentioned earlier, stock charts tell a story. A combination of price and volume are at the heart of the storytelling.
Understanding Scenarios And Trends
Consider these scenarios and what they reveal. To understand these scenarios and related trends, IBD stock charts show how the volume compares to the stock's 50-day and 200-day moving averages on the daily chart, and the 10-week and 40-week moving averages on the weekly chart.
In addition to the volume, also watch at what price the stock closes on an individual day or week. It's a sign of demand to see a stock close in the top half of the price zone for the day or week.
- Big Price Gain In Heavy Volume: This shows that the significant move in share price is backed by strong demand, as confirmed by heavy trade.
- Large Price Gain In Light Volume: Potentially signaling a head fake, the stock has risen but a lack of volume shows hesitation or uncertainty among large investors.
- Big Price Decline In Heavy Volume: One down day or week doesn't necessarily trigger a sell signal. But a significant decline in heavy trade is warning sign. It indicates that large investors may be heading for the exits.
- Small Price Decline In Light Volume: Below-average volume on a down day or week may indicate that large investors are generally holding on to shares in hopes of bigger gains. This scenario can emerge as a stock sets up a base or builds a handle.
Understanding the importance and meaning of price and volume is essential to understanding stock charts, chart patterns and buy points. Another key element for understanding chart patterns that form the basis for determining buy points is the concept of support and resistance.
Support And Resistance: The Key To Understanding Chart Patterns
Year after year, decade after decade, the same handful of chart patterns show up again and again. Technologies and company names will change, but these core patterns never do.
IBM (IBM) in the 1930s. Xerox (XRX) in the 1940s. Walmart (WMT) in the 1970s. Apple (AAPL) in the early 2000s. Whatever the leaders were then and whatever they are right now, the patterns do not change.
They continually repeat because they're based on human nature and the ever-present emotions of hope, fear and greed.
As we'll see, chart patterns — also known as bases or consolidations — serve as launching pads for a stock's big price move. Learning how to spot these formations enables you to buy stocks at the best time with the least amount of risk.
Before getting into different types of chart patterns like a cup with handle, double bottom or flat base, let's look at the basic concept behind them.At its core, learning how to read stock charts and chart patterns comes down to tracking support and resistance.
Think in terms of a "floor" of support and a "ceiling" of resistance.
Hitting A Ceiling Of Resistance
Whether due to a market correction, a problem with the stock itself, or a combination of both, a stock will sometimes go through a down period. When that happens, you can see the stock hitting this ceiling of resistance in the stock chart.
You can assess how aggressive the selling is by checking the price and volume action in the stock chart, as we saw earlier. As the downturn continues, look for signs that mutual funds and other large investors have stopped selling heavily and started to pick up more shares.
Such signs will come in the form of lighter volume on down days and weeks, and heavier buying on the upside. Trading will also start to tighten up, with less volatile price swings. Once the stock settles down, it will begin to move sideways and form the bottom of a base or chart pattern.
Finding A Floor Of Support
The bottom of the base forms the floor of support, which may come at a moving average like the 10-week or 50-day line. Or it may come around a certain price area for the stock.
If institutional investors believe in future prospects of the stock, they'll start to establish new positions or add to existing ones. Once the floor of support is established, the stock will begin to climb, forming the right side of the chart pattern.
Stock Charts Reveal The Best Time To Buy Stocks
After a stock has established a floor of support and built the right side of a chart pattern, it will eventually run into a new ceiling of resistance. That becomes a testing ground for the stock.
Will the stock bump its head against that ceiling and fall back down? Or will it punch through that ceiling in big volume and break out to new highs?
That line of resistance establishes the ideal buy point. If the stock has the power to punch through the ceiling in strong volume (and market trends are favorable), chances are high that the stock is ready for a new run.
Stock investing is all about keeping the odds in your favor.Such action in the stock chart shows that the stock has established support and found enough demand to break through that prior area of resistance. Known as a breakout, it gives investors the highest likelihood of success, with the least risk of failure.
Of course, there are no guarantees in the stock market. Depending on overall market conditions and other factors, some breakouts will fail. As part of the three key tenets of how to make money in stocks, waiting for a stock to form a chart pattern and break out is essential to understanding how to buy stocks.
The Best Stocks Form Multiple Chart Patterns And Breakouts
Like steppingstones, leading stocks typically form multiple chart patterns as they make their big moves over several months or even years. The process we just went over of finding support, hitting resistance, and breaking out past new buys points continues to repeat.
Below is a simplified version of what that looks like.
The biggest gains typically come on breakouts from early stage bases. After a stock has formed and broken out of a couple of chart patterns, risks increase. That's because once a stock has formed multiple patterns, it has, by definition, already made a significant climb. At some point, it will run out of steam and retreat. Then the stock will reset its base count by undercutting the low in the most recent pattern. That drops the count back to one, potentially setting the stage for a renewed climb.
How Bases, Market Trends Correlate
Note that there is a strong correlation between base counts and overall market trends.
First, chart patterns often form during market corrections. And breakouts from buy points tend to happen around the same time the market trend is showing rising strength or resilience as indicated in theThe Big Picture and Market Pulse.
Second, you'll often see stocks forming third-, fourth- or later-stage chart patterns when the market indexeshave also already made a significant move. So when using stock charts to pinpoint bases and buy points, also take into account the concept ofstock market timingdiscussed earlier. Understanding that relationship is key to understandinghow to invest in stocks.
Finally, the depth and length of chart patterns tend to mirror what is happening in the stock market indexes. In short and shallow market corrections, you'll see many stocks form similarly short and shallow chart bases. In a severe and extended bear market, you'll see that reflected in the chart patterns stocks form in that environment.
So it's not unusual to see growth stocks that made big gains in the prior bull market fall sharply and form long and deep bases in the bull market that follows.
Investing Tip:See how to count bases to manage risk and keep the odds in your favor.
New Highs And New Buys In Stock Charts
For each of the telltale chart patterns coverer here, a key requirement is that the stock be at or near a new price high as it breaks out.
A new price high is a sign of strength and an important reminder of this historical stock market fact regarding how to buy stocks:
- Stocks hitting new pricehighstend togo higher.
- Stocks hitting new pricelowstend togo lower.
Avoid stocks trending down and hitting new lows. To improve your stock investing, focus on stocks showing strength as they climb into new-high ground and break out of a sound chart pattern.
The New Highs list features stocks at or near new price highs.
The 3 Most Common And Profitable Chart Patterns
When getting started with stock investing and how to read stock charts, focus on the three primary patterns. While there are other types of bases, these are the most common and they consistently produce impressive gains in every market cycle.
By using stock charts to spot these bases, you'll be able to get in early on the best stocks to buy and watch.
So start by getting to know these three common chart patterns and the buy points they provide.
- Cups: Cup with Handle and Cup without Handle
- Double Bottom
- Flat Base
Cups: Cup With Handle
What To Look For In A Cup With Handle
Prior uptrend of at least 30%
To form a proper chart pattern, you have to have a prior uptrend. The idea behind bases is that after making a decent run, the stock takes a breather, then forms stepping stones to set up an even higher climb.
Base depth: 15%-30%
The depth of the base — measured from the peak on the left side of the cup to the lowest point of the cup — should be between 15% and 30%. In a severe bear market, the depth may be 40% — 50%. As a general rule, look for stocks that held up relatively well during the market correction. For example, let's say one stock on your watchlist dropped 35% while another's base depth is only 20%. All else being equal, the stock with the 20% decline could be forming a stronger base.
Base length: At least 7 weeks
The first down week in the base counts as week 1.
The minimum length for a cup with handle is seven weeks, but some can last much longer — several months or even a year or more. Be wary of any chart pattern that has the shape of a cup with handle but is only, say, five weeks long. That's typically not enough time for the stock to consolidate the prior gains. Such bases have a higher chance of failing.
Handle
The handle should be amildpullback on relativelylightvolume. The depth of the handle should be 10%-12%. Additionally, the handle should form in upper half of the base. The peak of the handle should be within 15% of old high on the left side of the cup.
A handle is a shakeout of weaker holders — those not committed to holding the stock longer term. A sharp decline of more than 12%-15% in heavy volume could indicate a more serious sell-off, one that might prevent the stock from launching a successful move.
If the handle begins forming too soon (i.e., in the lower half of the base), it could mean institutional buying is not yet as strong as it needs to be to push the stock higher.
Who Are Weaker Stock Holders?
Who are the weaker holders getting shaken out in the handle? Typically, they're investors who bought late, right at the end of the prior uptrend. When the stock sold off to form the left side of the chart pattern, they suffered a sharp loss. Getting a profit is no longer their goal. They just hope to recoup some of their losses. So as the stock nears that old high — and the weaker holders' break-even points — they start to sell.
Here's why that shakeout is healthy.
Having a lot of weak holders in a stock means that whenever the share price rises, these weak holders will sell shares, pushing the price back down. (This happens when a stock has excessive overhead supply.) Once most of the weaker holders are out of the picture, it's easier for the stock to move higher with less selling pressure or resistance.
What about the big investors who have been picking up shares as the stock formed the right side of the cup?
These investors are more committed and are holding onto their shares. That's why the volume in the handle is light. Only the weaker holders are selling. The large institutional investors are sitting tight in expectation of a new upward climb.
Ideal Buy Point: Clearing point of resistance in the handle
The ideal buy zoneis up to 5% above the ideal buy point.
The buy point in a cup with handle and other chart patterns is determined by a line of prior resistance, in this case the peak in the handle. If the stock can clear that peak (i.e., the prior ceiling of resistance) in heavy volume, chances are good it is ready to ride that breakout into a new run.
If the ideal buy point is, say, 30, then the buy zone would range from 30 to 31.50 — 5% above the optimal initial entry.
More About Ideal Buy Points
For best results, buy stocks as close to the ideal buy point as possible.
Avoid buying stocks that are extended more than 5% above the initial buy point.Once a stock climbs more than 5% above the ideal buy point, it's consideredextended beyond the proper buying range.
Stocks often pull back a bit after a breakout. So if you buy extended, there's a higher chance you'll getshaken outof the stock because it triggers the 7%-8% sell rule. (Learn more here about when to sell stocks.)
Volume on day of breakout: At least 40%-50% above average
On the day a stock breaks upward past its ideal buy point, volume should be at least 40%-50% higher than normal for that stock. That shows strong institutional buying. On many breakouts, you'll see volume spike 100%, 200% or more above average. Light or below-average volume could mean the price move is just a head fake, and the stock is not quite ready for a big run.
Also note that sometimes you will see a stock climb right up to the ideal buy point then run into renewed resistance. That's why you want to confirm demand by seeing a stock punch through that buy point in heavy trade.
Chart Patterns: Cup Without Handle
The cup with handle — also called a cup-shaped base or simply a cup — is a variation on the cup-with-handle chart pattern. As the name implies, it's essentially the same, except it doesn't have a handle. All the attributes (including heavy volume on the breakout), except for the buy point, are identical.
The buy point in a cup-shaped base is determined by the peak on the left side of the cup — the most recent area of resistance.
How To Buy Stocks On Breakouts From Cups
Below are examples of winning stocks that launched big runs from the cup-with-handle and cup-without-handle chart patterns.
Both the daily and weekly charts are included. As covered earlier, weekly stock charts show the longer-term trend, while the daily charts show the action on the actual day of the breakout. Be sure to use both!
Chart Patterns: Double Bottom
While the shape is different from a cup with handle, the core concept behind a double bottom is essentially the same.
- Mirroring The Market: Double bottomstend to form while the overall market is volatile, and that's reflected in the shape. You have one down leg, then the stock tries to rally but hits resistance and ends up pulling back to form a second down leg. The stock rebounds one more time and is finally able to punch through and move higher. Thebreakout typically occurs when the market indexes have also bounced back from a correction into a new uptrend.
- Support And Resistance: Like the cup with handle and all other bases, the buy point for a double bottom is determined by the most recent area of resistance. That's the peak in the middle of the W. Breaking through that resistance on unusually heavy volume shows institutional investors are back in the game, aggressively scooping up shares.
- Shakeout:Remember how the handle in the cup with handle shook out the weaker holders? You have the same concept here, just in a different place. Note how the bottom of the second leg in a double bottom undercuts the bottom of the first leg. That gets rid of the weaker holders, leaving more committed investors who create support for the stock's new run.
What to Look For
- Prior uptrend: 30% or more
- Base depth:40% or less
- Base length: At least 7 weeks (first down week in base counts as week 1)
- Peak in middle of W: Should form in upper half of base and be below left-side peak
- Undercut:Bottom of second leg down should be lower than bottom of first leg down
- Buy point: The peak in the middle of the W (buy range is up to 5% above the ideal buy point)
- Volume on day of breakout:At least 40%—50% above average
How To Buy Stocks On Breakouts From Double Bottoms
Below are examples of winning stocks that launched big price runs from a double-bottom chart patterns.
Chart Patterns: Flat Base
Earlier we saw how the best stocks usually form "stepping stones" as they make their big moves. They'll go up for a while, pull back to form a new chart pattern, then resume their climb — giving you multipleopportunities to make money. Flat bases are classic examples of that. They typically form after a stock has made a nice gain from a cup with handle or double bottom. That's why they're often considered second-stagebases.
Here are the key concepts regarding flat bases.
- Trading Sideways to "Digest" Earlier Gains:Stocks will oftenbreak out of a cup with handle or double bottom, run up at least 20%, then trade essentially sideways to form a flat base. It's a milder decline than what you see in other patterns — no more than 15%. The price range will usually remain fairly tight throughout the base. That indicates institutional investors establishing or adding to their positions, trying to buy shares within a certain price range. This allows them to increase their holdings without significantly driving up their average cost per share.
- Support and Resistance:Here again the buy point is determined by the most recent area of resistance — the highest price point within the flat base. Until the stock breaks through that "ceiling" (preferably in above average volume), it won't be able to launch the next leg of its climb.
- Shakeout:Like other patterns, flat bases also have a way of shedding weaker holders. Instead of a sharper sell-off like the handle in a cup with handle or the second-leg undercut in a double bottom, the flat base shakeout is more of a slow grind. The weaker, less committed investors just get worn out by the indecisive, sideways action and eventually lose patience and sell.
What to Look For
- Prior uptrend: 30% or more
- Base depth: 15% or less
- Base Length: At least 5 weeks (first down week in base counts as week 1)
- Buy point: The peak within the base (buy range is up to 5% above the ideal buy point)
- Volume on day of breakout: At least 40%-50% above average
How To Buy Stocks On Breakouts From Flat Bases
Below are examples of winning stocks that launched big price runs from a flat base.
How To Buy Stocks At Add-On And Alternate Buy Points
Cups, double bottoms and flat bases are the main chart patterns that launch big runs. But the best stocks will also typically offer additional buying opportunities as they make their climbs. You can use those entries to add to your existing position or, in some cases, initiate a new one.
Less Is More
Since these are considered secondarybuy points, it's a good idea to buy fewer shares than you would from an initial position in a cup with handle, double bottom or flat base.
That's especially true if you're buying more shares in a stock you already own. In that case, you always want to buy fewer shares than you purchased in the initialbreakout. That keeps you from running up your average purchase price too much.
Below are two of the most common alternate and add-on buying opportunities:
- Three-Weeks-Tight
- Pullback to 10-Week or 50-Day Moving Average
Buying Stocks Using Stock Charts: Three-Weeks-Tight
Like a flat base, this occurs after a stock breaks out, goes up for a while, then pauses to digest those gains. As the name implies, it only takes three weeks to form. (Stocks may also form four-weeks-tight consolidations.)
What to Look For
- Each weekly close should be within about 1% of the prior week's close. That's what creates the "tight" range you see in the stock chart. Remember to focus on the weekly closing prices. During the week, the share price may move around a bit, but you're focused on where it closes the week. What do the tight closes tell you? That institutional investors are holding onto their shares. Fund managers and other professionals expect more from the stock, so they're not taking their profits off the table. In fact, they're likely quietly accumulating moreshares from weaker holders that get tired of waiting and sell. That's what keeps the stock in that tight and narrow price range.
- Buy point: The peak in the formation, which is the most recent area of resistance. The buy range is up to 5% above the ideal buy point.
- Volume on day of breakout: At least 40% above average.
Below is an example of a stock that launched a big price run from a three-weeks tight.
Buying Stocks Off 10-Week or 50-Day Moving Average
After a stock has broken out of a proper chart pattern, it may pull back to the benchmark 10-week or 50-day moving average lines.
If the stock bounces off the moving average and shoots higher on heavy volume, it can offer a chance to buy shares. It shows institutional investors are stepping in to "support" the stock and protect their position. It happens around these moving averages simply because professional investors use those lines as key benchmarks.
What to Look For
- Look for light volume on the pullback. This shows professional investors are not aggressively selling shares. Volume may be above average certain days or weeks during the pullback, but overall it should be "drying up" or getting lighter as the stock moves lower toward the moving average line.
- Make sure the stock bounces off the moving average line and heads higher on heavy volume. You want the stock to rebound and show strength, not weakness, before you buy. This is not about "buying on the dips." Never buy a stock as it's moving down. Wait for it to bounce higher before investing.
- Buy as close to the moving average line as possible. As the stock bounces off the 50-day or 10-week moving average line, you want to buy as close to that line as possible. The farther away from the line you buy, the riskier it gets.
- Focus on the first two pullbacks. The best gains typically come from the first two pullbacks to the 10-week or 50-day moving average. By the time a stock's third or fourth retreat occurs, it likely has already had a good move. Chances are now higher that the pullback is actually the start of a more serious sell-off.
Below are examples of winning stocks that launched good gains from a pullback to the 10-week or 50-day moving averages.
Learn More About How To Invest In Stocks
Use the links below to learn more about stock investing and how to invest in stocks using IBD and The IBD Methodology — and discover how to stay both profitable and protected.
- How To Invest In Stocks: Investing For Beginners
- How To Make Money In Stocks: 3 Key Factors For Stock Investing
- Stock Market Timing: Can You Time The Stock Market?
- How To Handle Changing Stock Market Trends
- How to Buy Stocks
- Buying Stocks Using Stock Charts & Technical Analysis
- When To Sell Stocks
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