Stock Market Charts offer us a look at the emotions of Greed and Fear. They display historical data in a variety of perspectives.
We will take a short look at different styles of charts and which to use in specific circumstances.
There is a tremendous amount of knowledge to be had in Technical Analysis and its charts.
Trends, patterns, reversal signals, volume and price range are only the tip of the iceberg that is “charting”.
You need to understand that the validity of the information displayed is determined by the amount of data points viewed.
The longer and more data reviewed, the more valid the trend, price reversal, etc.
When you use charts in your decision support of trading, you must realize that while they have a significant use, they are not infallible and can fail to "indicate" in any given situation.
Thus, while we need them in our decision hierarchy, no single factor can ever be the "trigger" for a trading decision.
Here you will see an overview of the different styles of charts:
The most popular charts are the Line - Close Only, the Bar and the Candlestick – with the Candlestick chart becoming more and more popular everyday. Each has its pros and cons.
Most traders and investors alike agree that the "close" is the most important fact in any given period, considering that the price data during the period (whether it be a 1 minute, 5 minute or daily chart) is determined by the fight between the Buyers and the Sellers.
Thus, at the end of the period, on Close, the price is higher or lower than the starting price. This price then shows who "won" that period – if the price is higher, the Buyers won; if the price is lower, the Sellers won.
Line charts also offer a clean line that makes spotting patterns a little easier.
Conversely, by using only one factor (the Close), you lose some of the richness of the data – the range of the High and Low, and the relative Opening price.
Here’s an example of a Line – Close Only Chart:
The Bar Chart was the most popular in the past and is still widely used in Futures trading.
The Bar offers a complete data package – Open, High, Low and Close (OHLC). This style shows very clear lines for identifying trends up or down.
Their simplicity suits many Technical Analysts. Again, there is a down side to everything.
A Bar chart with a lot of data points may become congested and patterns more difficult to see. This is particularly true of 1 minute – 1 day charts.
The Bar itself is simple:
The Left Tab is always the Opening Price, The Right Tab is the Closing Price and the ends of the vertical “bar” tell you what the high and low are for any period.
In the following examples, you can clearly see the difference in a long-term Bar chart relative to a congested short-term one:
The Candlestick chart was actually created by a Japanese Rice merchant, named Munehisa Homma, in the Middle Ages.
If you remember our history, Technical Analysis didn’t become popular until the 1900’s, however, Homma has to be considered one of the "Fathers" for his early work in tracking rice prices through charting.
Like the Bar chart, the Candlestick is OHLC data. Homma created his candlesticks as “clear” and “shaded” to denote strength and weakness respectively.
Today we use "green" (clear) and "red" (shaded) to represent the buying pressure and selling pressure respectively.
Candlesticks are very useful in their graphic displays. One can see, at a glance, the overall trend in the price action by the colors.
They are even more useful in a "live" setting, where you can see the colors change as the buying and selling pressures oscillate.
The down side is that unless you study the more complex theories of Candlestick charting, you are missing a huge amount of their potential.
Here is how the Candlestick is formed:
Green’s Open low and Close High denote Buyers in control. Red’s high Open and a lower Close indicates the Sellers are in power.
The Shadows (lines above/below colored Real Body) tell us the High and Low of each period.
XYZ 5 Minute- 1 Day, Candlestick Chart: Between 10:05am and 10:20am, you can see the dominance of Green Candles, indicating the run up.
Between 10:25am and 11:10am, you can see the Sellers in control via the Red Candles.
You need to understand that charts need to be used for perspective. Rarely will you use only one chart.
You need to match the charts with the style and time period of your trade.
Typically, intraday trades will use a short-term chart such as a 1 minute-2 day in conjunction with a moderately longer chart like a 15 minute-10 day.
This allows the trader to "see" the transaction develop but can quickly refer to the longer period to understand where the price is relative to the overall trend.
Conversely, a longer period trade, such as a Swing or a Position trade, will require more data over a longer period.
In these cases, a trader might use a 5 minute-5 day in tandem with a 30, 60 or even a year long Daily chart for perspective.
Once again, we remind you that we are just touching the edges of this fascinating and useful body of knowledge.
Understanding charts, volume and technical indicators such as MACD, Stochastics, Bollinger Bands®, Relative Strength Indicators, the VIX and many more is mandatory for the serious Technical Analyst.