Reading the stock price charts

The primary tool used by technical analysts is the stock price chart. These charts, available on just about any financial website, usually plot a stock’s closing price every day. Charts usually come in several forms, including the:

• Line: Most of the stock price charts you see are usually line charts. Line charts, as their name implies, are simply a connect-the-dots line linking the closing prices of a stock each trading day.
• High-low-close: Line charts are simple, but they do obscure some of the relevant data from trading. If you look at a line chart, there’s no way to know how high or low stock prices got each day. The high-low-close chart, shown in Figure 19-1, attempts to solve this shortcoming of line charts. On each trading day, there’s a vertical bar, with the top portion representing a stock’s high price and the bottom, the low. Then there’s a line through the middle of the bar showing the price at which the stock closed.

  

• Candlestick: Candlestick charts pack even more information than line or high-low-close charts. Candlestick charts not only show you a stock’s high, low, and close, but also its open price. A stock’s open price is the very first price in a trading day that buyers and sellers agreed upon. The indicator on a candlestick chart looks like a rectangle with a vertical line protruding from the top, to mark the stock’s high, and from the bottom, to mark the low. You can take a look at a sample in Figure 19-2.

What technical analysts are looking for in the charts

If you’ve ever heard a technical analyst speak, it might seem like a bit of voodoo. Usually, technical analysts have a pen or marker in hand, start scribbling all over a price chart and talk about all sorts of patterns that they see. If you’ve ever been to a stargazing presentation at an observatory, you probably get an idea of what it’s like hearing a technical analyst describe a stock chart. Technical analysts try to connect dots on charts to find patterns they say can be revealing about a stock’s future. Technical analysts are looking for several things in the charts, including:

• Price patterns: If there’s one thing technical analysts fixate on, it’s the shape of the charts. Technical analysts think investors, being human, follow predictable cycles of fear and greed. These emotions cause stock prices to follow predictable scripts, or patterns, that may indicate where the stock is headed.
• What other people see: Even if you do all the fundamental research possible, you can still be dead wrong. Technical analysts attempt to look at a stock chart to either confirm or deny their belief about a stock’s future. If a stock is in free fall, technical analysts would assume other investors know something they don’t and would avoid it.
• Support and resistance levels: Through the constant tug-of-war between buyers and sellers, a stock attempts to settle at a price investors agree upon. Sometimes a stock will have difficultly breaking beyond a high point, or resistance level, and will routinely bounce off a low point, called a support level.
• Momentum: Technical investors, who are often short-term traders or speculators, often try to capitalize on the tendency of some stocks to gain steam either going up or heading down. If a stock starts to rally, technical investors take notice and assume those in the know expect the company to report something positive.

How technical analysis differs from fundamental analysis

Technical analysts and fundamental analysts are sometimes at odds with one other. Technical analysts believe all information about a stock that’s worth knowing is reflected in its stock price. Taking the time to study a company’s fundamentals is a waste of time, a pure technical analyst would argue, because everyone else has access to the same information and has either bought or sold the stock already.

Those are fighting words to fundamental analysts. Fundamental analysts, on the other hand, claim technical analysts fall victim to groupthink and fixate on changes in stock prices that tell investors nothing about the future. What’s more, fundamental analysts claim stock prices can get overvalued when investors become too optimistic about a stock and push its price above or below the company’s intrinsic value. You can learn how to calculate a stock’s intrinsic value in Chapter 11.

Using stock prices as your early-warning system

Even a lifelong fundamental analyst, who looks at technical analysis as glorified palm reading, may still benefit from the art of reading charts. When forecasting how a company’s revenue or earnings might look a year from now, fundamental analysts need to take educated guesses at what shape the economy or the company’s industry will be in.

Watching stock prices can be useful in helping a fundamental analyst form an opinion about the future. Because stock prices tend to foreshadow economic reality three, six, or nine months in advance, paying attention to stock price movements may tell fundamental analysts something about what the economy might look like.

Monitoring industry sectors, as described in Chapter 16, may be especially helpful. If you start noticing shares of companies that make durable goods, or high-ticket items like houses and cars, falling, that may very well be a tip-off that investors expect the economy to slow. That’s useful information you might consider when forecasting a company’s future earnings growth.

Looking up historical prices

Even if the technical analysis tools discussed in this chapter seem a little too, well, out there for you, you can still benefit from charts and historical stock price data. You might find yourself wanting to know what a stock price was in the past — so you can calculate a company’s valuation from years past. Perhaps you want to look up your cost basis in a stock, or how much you paid for it when you originally bought it. You’ll need to know your stock basis to measure your capital gain or loss for tax purposes.

You may also want to know what a stock price was, say, a year ago so you can measure how well or poorly a stock has done.

When you want to look up a historical stock price, it’s time to break out the stock price chart. Most online websites let you plot stock prices going back in history so you can see what a stock price was in the past. All the major financial websites let you pull up historical stock charts.

Because so many investors ask me for tips on looking up historical stock prices, I’ll step you through one way to accomplish this task. If you’re looking to get a stock’s price in the past, here’s how you’d do it using Yahoo! Finance:

1. Log onto Yahoo! Finance.

   Enter finance.yahoo.com into your Web browser.

2. Enter the stock’s ticker symbol.

   Enter the stock symbol on the top center of the page. Click on the name of the company when it pops up.

3. Launch the historical stock quotes engine.

   Click on the Historical data option on the top center part of the screen.

4. Choose the date you’re interested in.

   Scroll down until you see the date in history you’d like the stock’s price on. The system will tell you the stock’s high, low and closing price on that day.

Getting into the groove with moving averages

One of the first things most technical analysts plot on a stock chart is the moving average. The moving average tells you what a stock’s average price has been over a set period of time. Moving averages can be calculated for any period of time, but technical analysts usually use the following time periods:

• 10-day moving average. The stock’s average price over the past two weeks.
• 50-day moving average. The stock’s average price over the past quarter.
• 200-day moving average. The stock’s average price over the past year.

Technical analysts compare a stock’s current price to its moving average. If the stock price is greater than the moving average, that’s considered to be a bullish signal for the market. If the current stock price is less than the moving average, that’s a bearish signal.

If you’re going to choose a moving average to pay attention to, you should go with the 200-day. Technicians get very cautious when a stock price falls below the 200-day moving average, and may wait on the sidelines before buying back in until the stock rises above the 200-day moving average. When a stock falls below the 200-day moving average, that means that every investor who bought the stock within the past year, on average, is losing money. If the stock creeps upward, many of these disappointed investors are eager to dump the stock, making it difficult for the stock to rise.

Keeping an eye on trading volume

Technical analysts are very interested in the direction of a stock’s price. But most technical analysts also pay close attention, too, to how much trading volume is occurring. Trading volume measures how much investors are buying or selling a stock. If buyers and sellers are furiously trading shares back and forth, then trading volume is considered to be high, or active.

When trading volume is active, technical analysts figure they can trust the price movement to a greater degree. For instance, imagine a stock that soars to break into new high ground, but on low trading volume. A technical analyst would be skeptical of the move higher, because a relatively small group of investors powered it. Similarly, if trading volume is heavy, that tells the technical analyst there’s a great deal of volume, or conviction, behind the trade.

Table 19-1 summarizes the way a fundamental analyst might couple reading volume with price movements.

Your next question, though, might be how you can determine whether trading volume is higher or lower. The major stock market exchanges, including the Nasdaq and New York Stock Exchange, provide trading volume for the day and the average daily volume to most of the financial websites. Technical analysts compare a stock’s trading volume for the day with its average daily volume to determine whether buying and selling is active or not.

Using MSN Money’s site, you can obtain a stock’s daily and average daily volume following these steps:

1. Log into MSN Money at money.msn.com.
2. Enter the stock’s symbol in the field on the right side of the page labeled Search Stocks, ETFs, & More. Click the name of the company when it appears.

3. Read and interpret the volume.

   Look to the right, and you’ll see a line titled Average Volume. Here you’ll find the stock’s volume that day listed first. Want volume for other days? Hover your mouse over the stock chart on the left side of the page. You will find the stock’s average daily volume over the period of the chart in the pop-up box. When the day’s volume is considerably higher than average, then you can use that insight to analyze the significance of the stock price’s move.

The ABC’s of Beta

Beta, or the beta coefficient, is one of those rare market indicators that both fundamental and technical analysts can agree has value. Beta is a statistical measure of how volatile a stock is relative to the stock market at large. You might recall, from Chapter 11, how beta is used in the capital asset pricing model used to build a discounted cash flow model.

While beta is based on a somewhat complex statistical technique, as an investor, most of what you need is pretty simple. If an individual stock has a beta of 1, that means it is equally volatile as the general stock market. If beta is less than 1, then the stock tends to swing up and down less than the market. And if a stock’s beta is greater than 1, it is more volatile than the market.

A technical analyst might look at beta to provide clues on how wild to expect a stock’s ups and downs to be — or how closely its moves follow the rest of the market. When an investment’s beta is less than 1, in addition to being less volatile than the market, that might also mean the investment tends to not move in lockstep with the market. If an investment has a beta of 1, that means it’s more volatile than the market — but it might also mean it tends to gyrate with a similar pattern as the market. When an investment moves in lockstep with the market, it is said to be correlated with the market. Beta is available from nearly all financial websites.

The long and short of short interest

You’re probably used to buying stocks and hoping the companies do well so that the stocks rise. But an entire community of investors does the opposite — they hope stocks will fall. These investors, called short sellers, use a series of maneuvers to position themselves to profit if a stock declines in value.

Investors short a stock by first borrowing shares from another investor who owns them. The short seller, then, turns around and sells the shares immediately, pockets the proceeds and waits. The short seller then must buy the shares, hopefully at a lower price, and return them to the investor they borrowed from. If the stock falls, the investor makes money by buying the shares back at a lower cost than they sold them for.

You might never decide to bet against a stock yourself. But it may be useful for a fundamental analyst to know just how many people are shorting a stock they do own. There are three things to pay attention to when it comes to short interest:

• Short interest: A stock’s short interest is a measurement of how many shares of a company’s stock have been sold short.

  Just looking at short interest doesn’t tell you a whole lot. A company with more shares outstanding, or shares in investors’ hands, would naturally have more short interest than a company with fewer shares outstanding. You’ll want to compare short interest with another measure to get proper perspective, as I describe later.

• Average daily share volume: Remember volume, mentioned earlier? This data will be helpful again in interpreting how significant short interest is by putting short interest into perspective.
• Days to cover:Days to cover tells you how large a company’s short interest really is. Days to cover is calculated by dividing a stock’s short interest by its average daily volume. This statistic indicates how many days of typical trading it would take for the number of shares being shorted to trade hands.

The higher a stock’s days to cover is, the more heavily shorted it is. Fortunately, all three types of shorting data described earlier are available at Nasdaq.com. Just enter a stock’s symbol into the site, click on the name of the company, and a window will pop open. Click on the Short Interest option listed on the left-hand side of the page beneath where it says “Fundamentals.”

Determining what short interest means to a fundamental analyst is bit tricky. Some fundamental analysts like to see a stock that’s heavily shorted. If you’re completely confident in your fundamental analysis and know what a company is worth, and believe the stock is undervalued, heavy short interest can actually be a good thing. When stocks are heavily shorted, if the company delivers solid earnings, investors who shorted the stock may scurry to buy back the stock.

A rush by nervous short sellers to buy back a stock they wrongly bet against is called a short squeeze. Short squeezes can cause powerful stock rallies.

Fundamental analysts may also view a heavily shorted stock as a warning sign. After all, an investor who shorts a stock is exposed to a theoretically infinite loss, because there’s no real limit to how high a stock can rise. If investors are that confident a stock is going to fall, you want to make absolutely sure you’ve done a complete job with your fundamental analysis.

Short-selling, too, can fall prey to groupthink. These investors also pay the price as a result. During early 2021, a band of individual investors staged a “Reddit rebellion” against short sellers. Using online message boards, these clever investors found which stocks the short sellers were piling into with bearish bets. GameStop, a struggling video-game retailer, was the poster child. Short sellers controlled a giant chunk of the company’s shares outstanding. So, these Reddit investors then coordinated a plan to buy up the stock at the same time. With such a powerful flurry of buying, the shorts had to buy shares, too, to stop losses from getting larger. The result was spectacular. Shares of GameStop surged nearly 1,800 percent in early 2021 from its levels in December. Of course, the stock soon crashed when investors understood how shaky the company’s fundamentals were. But lots of money was made in a short period of time, at the expense of short sellers.

Understanding the types of options

Options come in two most basic forms, put options and call options. Put options give investors the right, but not the obligation, to sell a stock at a predetermined price at a set time in the future. Call options, on the other hand, give investors the right, but not the obligation, to buy a stock at a predetermined price at a set time in the future.

Investors may buy and sell both put and call options, driving their prices up and down, just as they would trade stocks. Table 19-2 shows you the four most basic options strategies, which you’ll want to understand in order to know how to interpret prices on options.

Paying attention to put and call price levels

If you want to get an idea of what investors are expecting from a stock, you’ll want to take a look at its option chain. An option chain tells you how much investors are paying for both put and call options that expire, or come due, at different times in the future.

Option chains are usually sorted by strike price, or the price at which the option kicks in. For instance, imagine you bought a call option for stock ABC at a strike price of $25 that expires in December. That means you have the right, but not the obligation, to buy the stock at $25 a share come December.

Fast-forward to December. Imagine the stock is now trading at $100 a share. Suddenly, having the right to buy a $100-a-share stock for just $25 a share is valuable, or in the money. However, if instead of trading for $100 a share, what if the stock is trading for $2.50? Not many people would want the right to buy a $2.50 stock for $25. At that point, your option is considered to be out of the money.

If you start noticing the price of call options with strike prices above the current market price going up, that’s an indication investors are expecting good things from the stock in the future.

Some technical analysts also pay attention to the volume, or level of trading activity, in options, too. In fact, the amount of trading in put and call options is the basis of another thing technical analysts watch, the put-to-call ratio, discussed in the following section.

Watching the put-to-call ratio

Now that you understand what puts and calls are, you might wonder how you might put the information to use. Again, as a fundamental analyst, you’re much more concerned about a company’s revenue and earnings rather than short-term trading noise. But, monitoring the level of puts and calls can tell you how many other investors either agree, or disagree, with your assessment of a company’s value.

The put-to-call ratio gives investors a quick look at how bullish or bearish investors are on a stock’s prospects. The ratio is simply the number of puts (which are bearish) divided by the number of calls (which are bullish).

The higher a stock’s put-to-call ratio, the more pessimistic investors are about a stock’s future.

There are online resources that help you see the balance between puts and calls. The Chicago Board Options Exchange’s site at www.cboe.com/data/PutCallRatio.aspx provides the put-to-call ratio for the entire market. You can also dig down deeper to an individual stock. After choosing the exchange (CBOE is a good choice in most cases), enter the stock’s symbol at the top of the page and click the Search button. Click the Download Report button. By comparing the trading volume and open interest of the puts and calls, you can see how investors are placing their bets. The open interest of options measures the total number of contracts that are outstanding by traders.

Using the market’s fear gauge: The Vix

One of the great strengths of fundamental analysis is that it gives you a framework to assess how much a business is worth. That way you can make an intelligent decision on whether the stock’s price is higher or lower than the business’s value. Fundamental analysts, in fact, often get their best deals when other investors are afraid to buy stocks and push stock prices down. Warren Buffett, in his 1986 letter to shareholders, put it this way: “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” But how can you tell if investors are greedy or fearful?

One of the biggest reasons why fundamental analysts might choose to pay attention to technical analysis and options is that they may help you see when other investors are feeling greedy and when they’re feeling nervous. When they’re nervous, you can be greedy.

There are many ways to get an idea of when other investors are fearful, which is valuable information for fundamental analysts. One popular indictor of investors’ fear is based on options trading. This indictor, called the Chicago Board of Options Exchange Volatility Index or Vix, is often looked at as a pretty valuable measure of investors’ fear. When the Vix is rising, that means investors are getting increasingly nervous. And when the Vix is falling, that means investors are getting complacent.

You can obtain current values of the Vix from the CBOE at www.cboe.com/tradable_products/vix. You’ll just need to scroll down a bit on the page. Historical values of the Vix are available at www.cboe.com/tradable_products/vix/vix_options. Most financial websites will also let you plot the Vix, if you enter the symbol. For instance, if you enter VIX in MSN Money, you can view its value over time.

Technical analysts have more than just these indicators. Stock charts and the patterns of stock prices form patterns with cool names like “head and shoulders” not to mention all sorts of other indicators like Relative Strength Index. Fundamental analysts can find ways to incorporate some of these tools. The RSI, for instance, tells investors if a stock is strong or weak compared to the rest of the market. If the RSI is 70 or higher the stock is relatively strong and if it’s 30 or lower it’s relatively weak. Again, the RSI can be another tool fundamental analysts can use when trying to decide when to actually put or sell a stock they’ve done traditional research on.

Giving fundamental data the technical analysis treatment

Some technical analysts love charts so much, they might even plot out some data that are traditionally considered to be for fundamental analysts. Even if you’re not onboard with technical analysis, there’s no question that sometimes, seeing fundamental data presented graphically may help you spot trends.

Plotting fundamental information, rather than just looking at table stuffed with data, may give you a unique perspective and help you to spot trends you didn’t notice before.

Price-to-earnings ratios, or P-Es, and dividend yields are two of the fundamental pieces of data that technical analysts most often will place on a chart. Looking at how P-E ratios are rising, or falling, over time can help you determine whether or not investors are getting overly giddy or cautious about a stock. You can read about the P-E ratio in more detail in Chapter 8 and the dividend yield in Chapter 10.

Slapping fundamental information on a chart may bring to light trends your eyes glanced over. There are online tools that make this pretty easy to do. Morningstar.com, for instance, provides a charting service that allows you to plot all sorts of measures important to fundamental analysts including P-E ratios and dividend yields. You can do this by following these steps.

1. Log onto Morningstar’s site at www.morningstar.com.

2. Enter the symbol of the stock you’re interested in.

   After you enter the stock symbol into the blank at the top of the screen, click on the name of the company. Next, click on the Chart tab below the name of the company. Next, choose the timeframe you’re interested in. Keep in mind, you must choose at least one month (1M) for this feature to work.

3. Select the fundamental data you would like to see plotted.

   You can plot a variety of fundamental measures, ranging from P/E ratio to earnings growth and price-to-book. Click the fundamentals option just to the right of the Compare blank. Select the Price/Earnings option.

4. View the data.

   Scroll down to see the data plotted for you in a chart.

Following the momentum of fundamentals

Technical analysts are often interested in following the momentum of stock prices, meaning the prevalent trend either upward or downward. Just as college basketball teams often get momentum during big games and start going on a hot streak, technical analysts believe stocks can turn hot and have the gust of investor enthusiasm at their backs. Momentum investors hope to pile into a stock while it’s still soaring, grab a quick gain and get out.

Classic momentum investing — or a type of speculation using technical analysis — is contrary in most ways to fundamental analysis. But fundamental analysts might consider borrowing a bit from this concept, as strange as it sounds, when examining fundamental data.

By watching for momentum in a company’s fundamentals, you might get a tip-off that something meaningful is taking place at a company.

One way to apply the concept of momentum to fundamental analysis is by studying earnings acceleration. Here, you’re not just looking for companies that are increasing their profitability every quarter or year. You’re being even pickier. You want to find companies that are increasing the rate at which earnings are growing.

To perform an earnings-acceleration analysis, you just need to have a company’s earnings growth rate for the last few periods. While it’s usually done using quarterly results, the analysis can be done using quarters or years.

Let’s stop talking hypotheticals and use Delta Air Lines as an example of momentum spotting. Why Delta? The COVID-19 outbreak in 2020 caused immeasurable damage to the travel market as the whole global economy shut down. But when the travel market started to mend in late 2020, fundamental analysts might have expected demand for travel to improve pretty quickly. Were they right?

Following is an example of how you might do a fundamental momentum analysis for Delta’s revenue for the four past quarters, shown in Table 19-3.

Your first step is calculating the growth rate between each period. A growth rate is the difference between the most recently reported quarter and the same period in the previous year’s quarter. You can review how to calculate growth rates in Chapter 4. Once you measure each year’s growth, you get a chart that looks like what you see in Table 19-4.

As you can see from Table 19-4, Delta’s revenue growth absolutely took off in late 2021. The growth rate slowed, or decelerated, in early 2022. In other words, the growth of the most recent period is less than the one before it. This is not the kind of trend that a fundamental analyst, looking for momentum, would be on the search for. But it’s still robust growth, showing the airline is recovering fast from the pandemic’s darkest days.

Fundamental analysts often look for quarterly earnings momentum, for instance, when trying to figure out how successful a new product is. New products can be critical to a company’s sustained earnings growth. And if something a company introduces is catching on with customers, an earnings-acceleration analysis might show something exciting is going on at the company.

Because this book is about fundamental analysis, only the basics of technical analysis are covered so you’re up to speed on the purpose and role of this very different way of studying stocks. If you’d like to dig into technical analysis deeper, not surprisingly, there’s an entire book dedicated to the topic: Technical Analysis For Dummies, 4th Edition, by Barbara Rockefeller (Wiley). There you’ll find everything you want to know about technical analysis and will never look at a stock chart the same way.