While technical analysis offers hundreds of indicators all designed to offer some insight in to the future direction of a stock's price, one cliché rings true for successful stock traders.

A picture is worth a thousand words.

Reading chart patterns is a basic skill that all stock traders should master, for no single technical analysis indicator has made me money in the way that understanding chart patterns has. My approach to stock selection is simple; find stocks with good chart patterns and ignore most other aspects of stock analysis. Amazingly, the ability to read stock charts only requires the mastery of six simple concepts.

Support

This is a floor price that investors have established for a stock. Based on all fundamental information available to investors, this is the lower boundary for what investors are willing to accept for the stock. It is the bottom line, and is important because a break through the bottom line often signifies new and negative information, or a change in investor psychology.

Resistance

The exact opposite of support, resistance is the ceiling price that investors have established for a stock, and represents the maximum price investors are willing to pay for a stock, based on all the fundamental information that they have to judge. Breaks through resistance are often motivated by new, fundamental information in the hands of some investors who can then justify paying more for the stock.

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Optimism

It has been said that investors should never fight the trend of the market. Ideally, we want to buy stocks that the market is optimistic about, since this optimism will help the stock to move higher. Optimism is characterized by rising bottoms on the price chart of the stock.

Pessimism

If the investment community is in a bad mood about a particular stock, that stock will not likely move higher since few investors will see the company's fundamentals in a favorable light. We can see pessimism on a stock chart if there are falling tops in the price behavior.

Volatility

Volatility equals uncertainty. Investors are not really sure about what the stock is worth if the stock's price volatility is high. Therefore, the market has come to some consensus on what the company is worth when there is relatively less volatility in price. Most good chart patterns show breaks from low price volatility, because breaks from low price volatility often occur when there is significant fundamental change in the company's business.

Abnormal Behavior

As new information becomes available to investors, price and volume behavior often become relatively abnormal. The reality of the stock market is that it is not fair, and some investors have access to information before others. When these investors act on new information, they often create abnormal activity.

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Good chart patterns are comprised of some combination of these six factors. For example, breakouts from Ascending Triangles often telegraph an up trend. Ascending Triangle Breakouts are defined as follows:

• Rising bottoms on the stock chart, showing optimism.
• A horizontal line of resistance at the top of the chart, showing an upward limit on fundamental value.
• A movement from high price volatility to low price volatility over time, signifying an increased consensus among investors on what the company is worth.
• Abnormal price and volume activity on the day that the stock breaks through the resistance price.

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