Here’s How to Take Your Stock Chart Reading to the Next Level

Chart reading is widely regarded as little more than pattern recognition. Traders look for bullish or bearish patterns, take a position, and then hope that the pattern plays out as it is supposed to. Sometimes it works, and quite often, it doesn’t.

What is missing in this approach to technical trading is context.

A bullish pattern in a poor market or when there is negative news flow just isn’t going to work as well as it would if the right conditions exist. A breakout pattern in a bull market has a much greater chance of success than the same pattern in a bear market, but many traders never make this distinction.

One of the best illustrations of how context and catalysts impact trade is the phenomenon known as “sell the news.” We have seen it numerous times in 2022 when there is a run-up to a big event and then an ugly selloff when the news is not viewed as positive. One good example is how the market made a furious run off the lows in June and then reversed and made new lows when it sold off on Fed Chair Powell’s speech at Jackson Hole. The chart was overbought heading into the news, and Powell was the catalyst that made the short setup work.

Here is a chart with each Fed decision so far in 2022. In almost every case, the Fed decision is close to a major turning point for the S&P 500, but in a few cases, the Fed helped to accelerate the trend when overbought or oversold conditions were not that extreme. The important lesson here is that if you contemplate the chart while considering potential catalysts like the Fed, it can greatly enhance your chances of effectively trading the move.

This not only applies to the indexes but to individual stocks as well. Individual stocks will move in tandem with the overall market to a great degree, so it is important to look at charts with that in mind. A breakout or a strong move on earnings is much less likely to produce a sustained move if overall market conditions are poor.

It is extremely important to not just study the chart pattern but to look at it in the context of the overall market and consider what news flow will impact it. A great chart in a bad market or with significant news will be quite different from a chart without any major outside factors working.

Charts are the most valuable tools that traders possess, but they have very limited predictive ability. The great benefit of charts is helping to identify the context in which news is occurring and help you better determine directional moves and how much momentum they can achieve.

Chart reading is not a science. It is an art, and the more aware you are of the environment that surrounds a chart, the more useful the chart will be.