How to Make Money in Stocks Summary (C1 & 2): Reading Charts

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You cannot ignore the charts.

For over a hundred years there have been companies with meteoric rises, and the majority of them repeat specific chart patterns just before the rise.

Of course, you can’t ignore the fundamentals either.

The combination of finding stocks with big increases in earnings, sales, and return on equity along with the display of classic chart patterns is what will allow you to pick winning stocks at the right time.

Learning to read and interpret the charts is a skill that any diligent investor can (and should) learn.

A stock's price and volume history are recorded on charts to help investors assess the health of a company. The charts often give you key indicators of when to buy and sell. They cannot be ignored.

On the charts, bases are areas of price correction and consolidation after an earlier price advance. It is the period in which you see the patterns in charts forming as a result of price and volume movement.

You must learn to diagnose whether the price and volume movements signal strength or weakness.

Major advances spring from strong, recognizable patterns. When a pattern fails, it is always because of a faulty base.

The authors of the book analyzed the greatest winning stocks in the past and discovered they all shared seven common characteristics. These seven characteristics are what form the CAN SLIM formula.

They also discovered several chart patterns that repeated throughout these winning stocks.

Human nature doesn’t change, and neither does the law of supply and demand. This is why, when it comes to picking stocks, you can look back to help you predict the future.

The cup-with-handle pattern is one of the most important and they generally form over three to six months.

All strong price patterns will have a clear uptrend before forming its base pattern. Look for at least a 30% increase in price in the previous uptrend along with improving relative strength and substantial volume increase in the prior uptrend.

Growth stocks often create cup patterns during intermediate declines in the general market. Be cautious of any stock that downturns more than two and a half times the market averages.

Additionally, stocks with no pullbacks are often more risky.

The handle of the cup-and-handle pattern generally forms over one or two weeks.

This is where the price drops below a prior low and the volume may dry up.

Cups without handles have a higher failure rate.

A well formed handle will form in the upper half of the cup formation and will also be above the 10-week moving average.

In a bull market, the price drop of the handle should not be more than 8% of its peak, unless the cup is exceptionally large.

Stocks under accumulation should always display at least some tight areas.

On a weekly chart, tight areas are characterized by several weeks of small price variations between the high and low for the week.

When a stock breaks out of the cup and handle pattern, this is the pivot point.

At that stage, the volume for the day should increase at least 40% above normal.

You need discipline to wait for this pivot point. You are not trying to buy at the cheapest price.

Instead, you want to buy when your chances of success are highest.

Pivot points usually occur at 5% to 10% below the stocks prior peak. The peak of the handle is what usually determines the buy point, which is below the base’s actual high.

If you wait for an actual new high, you will be buying too late.

At the low of the cup and the low of the handle, there should be a lack of volume. This is a sign of a healthy stock under accumulation.

Big volume spikes are also very telling, especially at key points. They symbolize institutional buying and selling.

A good sign is when the weeks where the stock closes up in price with above average volume outnumbers the weeks that it closes down in price with above average volume.

Bear markets are when the majority of price patterns are created. This can last several months, or in rare cases, several years.

By following proper sell rules, you will have cashed out before the bear markets take grip.

Do not buy break-outs during a bear market! Almost all patterns will be faulty.

Instead, be patient and wait for the bulls to take over again.

Use the time to build up cash and analyse your prior decisions. Study carefully your winners and losers and create new rules to prevent future losses and increase future wins.

Then, when the bull cycle starts again, you will be ready.

The saucer-with-handle pattern is like an extended, shallower cup-with-handle pattern.

The double-bottom pattern resembles a W and may or may not include a handle.

The second bottom should be the same or lower than the first.

The buy point is the top right side of the W, unless it has a handle, in which case, buy at the peak of the handle.

The flat-base is a second stage base that occurs after a stock has risen at least 20% or more off a previous pattern. It is a good time to buy if you missed the first rally.

The flat-base will move sideways for 10 to 15 weeks in a tight price range and will not correct more than 15%.

This formation occurs after moving up from a cup-with-handle or double-bottom and usually lasts four to seven weeks.

Corrections are usually not more than 15%.

High, tight flags are one of the strongest patterns but also the hardest to interpret and quite rare.

The stock rises 100% or more within a couple of months and then corrects no more than 25% over three to five weeks before skyrocketing higher.

Sometimes a strong stock will break out of its base but is unable to increase the normal 20% to 30% because the general market begins to lower.

What will happen is that the stock will pull back and start to create a second base on top of its previous one while the general market continues to decline.

When the market bear phase ends, this stock is likely to be among the first to skyrocket.

Ascending-bases are similar to flat bases.

They occur after a stock has broken out of a cup-with-handle or double-bottom and have three pull-backs from 10% to 20%, with each low point higher than the previous one.

The pullbacks usually occur due to the overall decline of the market.

There are many more patterns known to traders, but many of them were developed a long time ago and, after extensive study, have proven to be unreliable.

They include triangles, coils, pennants, triple bottoms, inverse head and shoulders, and so on.

Additionally, wide-and-loose charts in general usually fail, though they may tighten up later.

The most reliable patterns must have a minimum of seven weeks of price consolidation. The only exceptions are high, tight flags, flat bases of at least five weeks, and the square box of at least 4 weeks.

Any base below four weeks should be avoided.

Although the inverse-head-and-shoulders pattern is unreliable to buy, the head-and-shoulders pattern is a very reliable indicator to signify the top out of a stock, if interpreted properly.

The right shoulder must be slightly below the left one.

Buying stocks that show the highest relative price strength amongst best performers is not enough.

Instead, you need to buy stocks that are performing better than the general market just as they start to emerge from a solid base.

Once the stock has advanced rapidly and has an overextended relative price strength, you must sell.

When a stock shows significant areas of price resistance after reversing from a downtrend to an uptrend, it is a sign of overhead supply.

Never buy a stock that has a lot of recent overhead supply.

A stock that breaks into new high ground for the first time has no overhead supply, which is a plus.

It is a good idea to track all new stock issues over the previous ten years because these younger companies will probably be amongst the best performers over the next year or two.

Growth stocks usually experience their fastest growth between their fifth and tenth years in operation.

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