Article Reviews, Trading

How to Read the Technical Strength of a Stock from the Charts

Came across this series of 10 educational articles from Investor’s Business Daily (IBD) on “How to Spot a Fine Chart”. Link here. This is a great set of articles, short and to the point.

To be able to quickly assess how good or bad the technical action of a stock is, is critical for swing trading. It is also important if you want to time a good entry into the stock that you are buying for fundamental reasons.

The series of articles gives some very good starting tips on what to look for. Key points below:

  1. Left side of a base
    • The left side of a cup-and-handle pattern should show a smooth and orderly decline without serious (huge and scary) volume surges. The weekly closes should also close in the upper 60% of the weekly range, which shows that funds are adding to their positions as the stock declines.
  2. Stalling
    • Watch for distribution that shows up in the form of stalling, i.e. heavier volume without price progress.
  3. Upside reversals
    • Watch for upside reversals, i.e. a stock recovering from a day’s decline to finish near the day’s high (same thing for weekly charts). This means people are buying into the decline.
  4. Accumulation / distribution
    • Look for stocks in bases with more up weeks with high volume than down weeks with high volume. This shows accumulation by professional investors.
    • Note however that if the stock was declining in the left side of a base with high volume, but it closed in the upper 60% of the weekly range, it is considered accumulation and not distribution.
  5. Tight action
    • Tight trading (i.e. weekly closing prices that vary 1% to 2% from the prior week) indicates quiet accumulation by institutional investors.
    • The narrow trading range is a result of high conviction which results in low volatility in cup-and-handle patterns, flat bases, or three-tight-weeks patterns.
  6. Depth of base
    • The decline from high to low of a cup in most cases will generally not exceed 33%. The shallower the base, the more it shows that institutions are unwilling to unload the stock.
  7. Proper handle
    • The handle represents a quiet shakeout (no volume surges) over at least 5 days. Impatient small investors unload the stock to institutional investors when the stock couldn’t push through the previous peak.
    • The handle should be in the base’s upper half, and should not sag more than 12%.
    • The handle’s lows should slope lower, because lows that wedges up show investors buying in without the necessary shakeout that can propel the stock higher.
  8. Double bottom
    • In a proper double bottom base, the second low must undercut the first low (i.e. 2nd low goes even lower). This shakes out the weak hands which can help the stock to move up higher later.
  9. Big volume on breakout
    • A good stock should break out of a base with high volume (i.e. 40% or more above the 50-day average volume).
  10. Big shakeout
    • A good stock recovers quickly after a shakeout which can be caused by no news, analyst downgrades, company-specific news, economic reports, etc.

Other points that I would add are:

  1. Look at the price history over a longer time period, what is the characteristic of the stock? is it very volatile with huge up and down swings? is it jumpy with frequent gap ups? with gap downs? or with both gap ups and gap downs? then determine whether this is a kind of stock that you are comfortable playing.
  2. What stage is the stock in? What’s the overhead resistance like? How’s the relative strength?
  3. Start with the daily chart and look out for all the points above.
  4. Look at the weekly chart to identify any patterns (e.g. cup-with-handle, double bottom, etc.).
  5. Do a more detailed bar-by-bar scan of the past 10 trading days.
  6. Zoom in to the intraday chart (recommend to start with 5-min) to look at the trading in the recent few days.
  7. For anything that you are suspicious of from the daily chart, or things that you want to confirm, zoom into the intraday chart as much as necessary (start with 5-min, if not sufficient, look at the 1-min chart).
  8. Pull up the chart of the stock index (e.g. SPY, QQQ), look for the most recent strings of consecutive up days and consecutive down days, take note of those days, and see how your stock performed in those days (e.g. did it surge up during the good times? and hold fast during the bad times?).



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