Introduction of chart
A chart is a graphical representation of data points. It is the heart and soul of a technical analyst, who uses it to recognize various patterns with the objective of making trading and investment decisions from it. Technical analysts are frequently also called chartists given that they spend a major portion of their time looking at various charts. Besides providing historical information about price, a chart can also provide historical information about volume and open interest, both of which will be discussed in greater detail later. A chart can plot close only data or can even plot all four elements of a period’s range – open, high, low, and close. In this topic, we will talk about some of the most commonly used charts in technical parlance.
Below are some of the chart types:
- Line chart
- Bar Chart
- Japanese Candlestick
A line chart is the most basic and simplest type of stock charts that are used in technical analysis. The line chart is also called a close-only chart as it plots the closing price of the underlying security, with a line connecting the dots formed by the close price. In a line chart the price data for the underlying security is plotted on a graph with the time plotted from left to right along the horizontal axis, or the x-axis and price levels plotted from the bottom up along the vertical axis, or the y-axis. The price data used in line charts is usually the close price of the underlying security. The uncluttered simplicity of the line chart is its greatest strength as it provides a clean, easily recognizable, visual display of the price movement. This makes it an ideal tool for use in identifying the dominant support and resistance levels, trend lines, and certain chart patterns.
However, the line chart does not indicate the highs and lows and, hence, they do not indicate the price range for the session. Despite this, line charts were the charting technique favored by Charles Dow who was only interested in the level at which the price closed. This, Dow felt, is the most important price data of the session or trading period as it determined that period’s unrealized profit or loss.
Line charts or close-only charts are still favored by numerous traders who agree the closing price is the most important data and are not concerned with the noise created price spikes and minor price movements, or the speculation that characterizes the start of the trading session.
A bar chart provides more information than a line chart as it displays not only the closing price but also the opening price, the high price, and the low price. A bar chart consists of a vertical line and two small horizontal dashes, one on the left of the vertical line and one on the right of the vertical line. The top of the vertical line represents a period’s high, the bottom of the vertical line represents a period’s low, the small horizontal dash to the left of the vertical line represents the period’s open, and the small horizontal dash to the right of the vertical line represents the period’s close. While the length of the horizontal dashes remains the same, the length of the vertical line could vary depending on period’s trading range. The larger the period’s trading range, the larger will be the length of the vertical line, and the smaller the period’s trading range, the smaller will be the length of the vertical line. If the period’s close is above the open, the right horizontal dash will be above the left horizontal dash, and if the period’s close is below the open, the right horizontal dash will be below the left horizontal dash. Just like in case of line chart, in case of a bar chart also, price is plotted along the vertical Y-axis and time is plotted along the horizontal X-axis.
While the bar chart displays all the four data points, it still lacks a visual appeal. This is probably the biggest disadvantage of a bar chart. It becomes tough to spot potential patterns brewing when one is looking at a bar chart. The complexity increases when a trader has to analyze multiple charts during the day.
Hence, for this reason, the traders do not use bar charts. However, it is worth mentioning that there are traders who prefer to use bar charts.
History of the Japanese Candlestick
Before we jump in, it is worth spending time to understand in brief the history of the Japanese Candlesticks. As the name suggests, the candlesticks originated from Japan. The earliest use of candlesticks dates back to the 18th century by a Japanese rice merchant named Homma Munehisa.
Though the candlesticks have been in existence for a long time in Japan, and are probably the oldest form of price analysis, the western world traders were clueless about it. It is believed that sometime around 1980’s a trader named Steve Nison accidentally discovered candlesticks, and he introduced the methodology to the rest of the world. He authored the first-ever book on candlesticks titled “Japanese Candlestick Charting Techniques” which is still a favorite amongst many traders.
Most of the candlesticks pattern still retains the Japanese names; thus giving an oriental feel to technical analysis.
What is Candlestick charts
Candlestick charts provide the same information as OHLC bar charts, namely open price, high price, low price and close price, however, candlestick charting also provide a visual indication of market psychology, market sentiment, and potential weakness, making it a rather valuable trading tool.
Candlesticks indicate a bullish up bar, when the closing price is higher than the opening price, using a light color such as white or green, and a bearish down bar, when the closing price is lower than the opening price, using a darker color such as black or red for the real body of the candlestick. Thus, on a green candlestick, the close price will be at the top of the candlestick real body and the open price at the bottom as the close price is higher than the open price; conversely on a red bar the close price will be at the bottom of the candlestick real body and the open price at the top as the close price is lower than the open price. For both a bullish and a bearish candlestick, the high price and the low and the low price for the session will be indicated by the top and bottom of the thin vertical line above and below the real body. This vertical line is called the shadow or the wick.
Charting on Different Time Frames
Technical traders analyze price charts to attempt to predict price movement. The two primary variables for technical analysis are the time frames considered and the particular technical indicators that a trader chooses to utilize.
The technical analysis time frames shown on charts range from one-minute to monthly, or even yearly, time spans. Popular time frames that technical analysts most frequently examine include:
- 5-minute chart
- 15-minute chart
- Hourly chart
- 4-hour chart
- Daily chart
The time frame a trader selects to study is typically determined by that individual trader’s personal trading style. Intra-day traders, traders who open and close trading positions within a single trading day, favor analyzing price movement on shorter time frame charts, such as the 5-minute or 15-minute charts. Long-term traders who hold market positions overnight and for long periods of time are more inclined to analyze markets using hourly, 4-hour, daily, or even weekly charts.
Price movement that occurs within a 15-minute time span may be very significant for an intra-day trader who is looking for an opportunity to realize a profit from price fluctuations occurring during one trading day. However, that same price movement viewed on a daily or weekly chart may not be particularly significant or indicative for long-term trading purposes.