Understanding the charts of the instrument you are trading provides an imperative to trading. When you board on online trading there are three main chart types that are popular among trading circles. Each chart has their level of information according to the traders’ individual skill level:
Line Chart – The most basic of charts, and the stepping stone for the beginner trader. This chart represents only a closing price over a period of time, the closing price is often considered the most important element in analysing data. This is in essence, how the line chart is formed: by connecting the closing prices over a set time frame. There is no visual information or trading range, meaning no highs and lows and nothing on opening prices.
Bar Chart – Expanding in more detail on the line chart, the bar chart includes several more key fragments of information that are added to each data point on the graph. Made up of a sequence of vertical lines where each line is a representation of trading information. They do represent the highs and lows of the trading period as well as the opening and closing price. The open and the close price are represented by a horizontal shorter line.
The open price is the ‘dash’ that is located on the left side of the vertical bar and conversely the close price indicated by a similar horizontal line, however, to the right side of the bar. Understanding this chart is simple, if the left dash (which is open price) is lower than the right dash (closing price) then the bar will be shaded in green, black or blue and represents a price increase and the instrument gained in value. The opposite is true and the decreased value of the stock is indicated in red.
Candlestick Chart – Once you have mastered the line and bar charts, you can graduate to the candlestick chart which will be easier to understand as it is similar to the bar chart. The vertical lines of both charts illustrate the trading period’s price ranges, while the body of the candle uses different colours to represent the market changes of that time period.
Dating as far back as the 17th century, the Japanese began using the technical analysis to trade on rice, although quiet different to the US version created around the 1900s their principles are similar.
In order to start creating and reading a candlestick chart, one should know that the data contains highs, lows, open and close prices.
The ‘hollow’ and the ‘coloured’ portions are called the body. The long thin lines above and below the ‘body’ represent the high or low ranges and are also referred to as either shadows, wicks or tails. Should the lines be placed at the top of the body this will tell you the high and close price, while the line at the bottom of the graph indicates the low and the low’s close price.
The colours of the candle body do vary from broker to broker, where they could either be green or blue, illustrating a price increase or red being a decrease in price, or hollow candlesticks is where the close price is higher than the open price which will indicate to traders to BUY. Filled / coloured candlesticks where the close price is less than the open will indicate a SELL position.
Long versus short bodies will indicate the buy or sell pressure among traders. Short bodies represent there was very little price movement and are often treated as a consolidation pattern, known as doji.
Doji is an important facet of the candlestick graphs as they provide information in a number of patterns. These form when the instruments open and close prices are virtually equal and there’s not much price difference. The relevance of a doji candles are to show traders that either: After a long white or green candlestick the buying pressure is starting to weaken, or after a solid long (blue or black) candle that the selling pressure is starting to decrease and the supply and demand are starting to even out.
One of the most popular and reliable patterns of graphical analysis is the head and shoulders pattern.
This pattern is a reversal pattern, that when is formed will be a sign that the current trend will see a reversal soon. There are two versions of the head and shoulders pattern:
- Head and shoulders Top: Generally formed at the peak of an upward trend and signals that the asset’s price is set to fall once the pattern is completed.
- Head and shoulders Bottom (or Reverse Head and Shoulders): Usually forming during a downward trend, the head and shoulders bottom pattern signals that the asset’s price is set to rise.
Both have similar visual construction as each contain four main elements: two shoulders, a head and a neckline. Patterns are formed when the neckline (support and resistance) is broken and a second shoulder is formed. Heads and shoulders are formed by peaks and valleys on a graph. There are many other formations that traders turn to for analysing trade setup such as: Double top/bottom, triple top/bottom, Pinocchio, bullish/bearish engulfment, etc.