Stock Market Charting Tips to Prosper

Published in ASX Newsletter, November 2009 by Dale Gillham

It is two years since the Australian sharemarket reached its record high of 6873.20 points on November 1, 2007. 

The global financial crisis that followed hit many investors and traders hard, and given the condition of many of the world's economies and their uncertain future, we need to accept that the landscape of the Australian market has changed.

We are no longer in a long-term bull market and what worked before the sub-prime meltdown is unlikely to work now.

Strong bull markets as experienced between 2003 and 2007 tend to hide the mistakes of the uneducated, given that many more shares were rising in price during that period. 

In the current climate this is no longer the case, therefore we cannot behave like fair-weather sailors and hope for the best. 

Instead, a well-planned strategy is required if traders and investors are to survive in the market over the next few years.

During the bull market many people called themselves traders simply because they bought and sold shares. 

When questioned on how they analysed the shares they were buying and selling, many said they read reports in newspapers and on websites, and occasionally looked at online charts with their broker.

My further questioning revealed that although many had a rough idea of the fundamental information they needed to assess a share, they had little or no idea what they were looking at when it came to understanding how to interpret a chart. 

None had a plan or understood anything about money management.

An educated trader understands the importance of a trading plan, how to analyse a share to know why they are buying and selling, and how they will manage the trade. 

Most importantly, they also implement strong money management rules such as a stop-loss and position sizing to ensure they minimise risk and maximise profit.

More recently I have seen traders and investors begin to place more emphasis on charting techniques in an attempt to make better-informed decisions about their investments, although in my experience this has the tendency to compound the problem if they do not understand how to correctly interpret a chart.

Beware the micro view

A major trap for the uneducated during volatile times is their tendency to act on emotions rather than logic. 

Further, they often delve into the micro view of the market or share they are analysing by watching it daily. 

They do that because of fear of losing, and it is this emotion that is amplified when there is no strategy in place. 

It is no wonder that many have lost heavily since 2007.

Another major trap is that the majority do not use stop-losses. 

I am staggered by the number of people who hold shares and never sell. 

Telstra is a prime example of a share that should have been sold at least 10 years ago, given that it has fallen by more than 60 per cent in that time. 

I also find that those who do use stop-loss points often set them far too tightly and in the end increase their losses, which is exactly what they were trying to avoid.

With a little knowledge, these sorts of mistakes need not be made.

Some simple tips to help you achieve your goals in the sharemarket

First, when analysing a bar chart, always look at the monthly chart and analyse the data over as many years as possible. 

This will help you avoid the irrational decisions that are often based on short-term emotion; after all, most people invest for the medium to long term. 

Daily charts are next to useless for 99 per cent of people who look at them, including traders, because you cannot adequately assess the trend. 

If you are a more active trader, the weekly chart can assist you with your analysis, although again make sure you analyse as much data as possible.

To illustrate why daily charts are ineffective, I have included a chart of the All Ordinaries index (Figure 1, below), which provides a microscopic view of the market. When I have shown this to traders, most indicated that the market was going up and they would buy.

Share Trading and Education

Figure 1: All Ordinaries index - 1 day bar chart Click to enlarge

Now look at the same period of time on a weekly chart of the All Ordinaries index (Figure 2 below). 

The box on the chart is the same period as reflected in Figure 1, above. 

When I show this chart to people they tell me the market is falling away. 

As you can see, analysing the bigger picture enables you to make more informed decisions, especially when it comes to determining the trend of the market.

Share Trading and Education

Figure 2: All Ordinaries index - weekly chart Click to enlarge

Implementing a solid trading plan also means you will not need to look at your charts more than once a week because you will know what your goals are for the trade. 

Remember, trading is about creating a lifestyle, not making it your lifestyle.

When looking for shares to buy, stay within the top 100 listed on the Australian market, because these are the safest and offer the best opportunity to make a profit. 

All too often investors think they need to trade the penny dreadful shares to make money, but there is nothing further from the truth.

Anyone who owns a share in this market needs to use a stop-loss. 

Failure to do so will result in taking unnecessary risks. 

There are various stop-losses you can use depending on what you are trading; for example, the stop-loss I would use for a blue chip is different to the one I would use for a speculative share or CFD. 

As a general rule of thumb, I always set my stop-loss at 15 per cent below the purchase price when trading blue chips.

Finally, when analysing charts do not get caught up in the high-tech complex indicators that are bandied about, such as MACDs and stochastics, etc. 

Applying a simple trend line to a chart is far more effective and more profitable. 

It will make your life much easier, have you trading less, and make more money. That has to be good!

To learn how you can confidently and profitably trade the stock market click here.

Back to Articles