As we discuss about what is Technical Analysis and difference between technical analysis and fundamental analysis by example in last post . We also discuss about Assumptions and versatility of Technical Analysis . Today we are going to discuss about The Chart Types In Technical Analysis .
Having recognized that the Open (O), high (H), low (L), and close (C) serves as the best way to summarize the trading action for the given time period, we need a charting technique that displays this information in the most comprehensible way. If not for a good charting technique, charts can get quite complex. Each trading day has four data points’ i.e the OHLC. If we are looking at a 10 day chart, we need to visualize 40 data points (1 day x 4 data points per day). So you can imagine how complex it would be to visualize 6 months or a year’s data.
As you may have guessed, the regular charts that we are generally used to – like the column chart, pie chart, area chart etc does not work for technical analysis. The only exception to this is the line chart.
The regular charts don’t work mainly because they display one data point at a given point in time. However Technical Analysis requires four data points to be displayed at the same time.
1. Line chart
2. Bar Chart
3. Japanese Candlestick
The focus of this post will be on the Japanese Candlesticks however before we get to candlesticks, we will understand why we don’t use the line and bar chart.
The line chart is the most basic chart type and it uses only one data point to form the chart. When it comes to technical analysis, a line chart is formed by plotting the closing prices of a stock or an index. A dot is placed for each closing price and the various dots are then connected by a line.
If we are looking 60 day data then the line chart is formed by connecting the dots of the closing prices for 60 days.
The line charts can be plotted for various time frames namely monthly, weekly, hourly etc. So ,if you wish to draw a weekly line chart, you can use weekly closing prices of securities and likewise for the other time frames as well.
The advantage of the line chart is its simplicity. With one glance, the trader can identify the generic trend of the security. However the disadvantage of the line chart is also its simplicity. Besides giving the analysts a view on the trend, the line chart does not provide any additional detail. Plus the line chart takes into consideration only the closing prices ignoring the open, high and low. For this reason traders prefer not to use the line charts.
I hope you clearly understand why line chart is not important for technical analysis . If you have any query or doubt write down in comment box . Now we discuss about bar chart .
The bar chart on the other hand is a bit more versatile. A bar chart displays all the four price variables namely open, high, low, and close. A bar has three components.
The top of the bar indicates the highest price the security has reached. The bottom end of the bar indicates the lowest price for the same period.
indicates the open
indicates the close
For example assume the OHLC data for a stock as follows:
Open – 67
High – 70
Low – 60
Close – 64
For the above data, the bar chart would look like this:
As you can see, in a single bar, we can plot four different price points. If you wish to view 5 days chart, as you would imagine we will have 5 vertical bars. So on and so forth.
Note the position of the left and right mark on the bar chart varies based on how the market has moved for the given day.
If the left mark, which represents the opening price is placed lower than the right mark, it indicates that the close is higher than the open (close > open), hence a positive day for the markets. For example consider this: O = 46, H = 51, L = 45, C = 49. To indicate it is a bullish day, the bar is represented in blue color.
Likewise if the left mark is placed higher than the right mark it indicates that the
close is lower than the open (close <open), hence a negative day for markets. For example consider this: O = 74, H=76, L=70, C=71. To indicate it is a bearish day, the bar is represented in red color.
The length of the central line indicates the range for the day. A range can be defined as the difference between the high and low. Longer the line, bigger the range, shorter the line, smaller is the range.
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 really hard 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. But if you are starting fresh, I would strongly recommend the use of Japanese Candlesticks. Candlesticks are the default option for the majority in the trading community.
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 actually 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 pattern in candlesticks still retains the Japanese names; thus giving an oriental feel to technical analysis.
1. Conventional chart type cannot be used for technical analysis as we need to plot 4 data points simultaneously
2. Line chart can be used to interpret trends but besides that no other information can be derived
3. Bar charts lacks visual appeal and one cannot identify patterns easily. For this reason bar charts are not very popular
We are going to discuss about Candlestick Anatomy in next post . If you have any query or suggestions write in the comment box .
Having recognized that the Open (O), high (H), low (L), and close (C) serves as the best way to summarize the trading action for the given time period, we need a charting technique that displays this information in the most comprehensible way. If not for a good charting technique, charts can get quite complex. Each trading day has four data points’ i.e the OHLC. If we are looking at a 10 day chart, we need to visualize 40 data points (1 day x 4 data points per day). So you can imagine how complex it would be to visualize 6 months or a year’s data.
As you may have guessed, the regular charts that we are generally used to – like the column chart, pie chart, area chart etc does not work for technical analysis. The only exception to this is the line chart.
The regular charts don’t work mainly because they display one data point at a given point in time. However Technical Analysis requires four data points to be displayed at the same time.
Below are some of the chart types of Technical Analysis :
1. Line chart
2. Bar Chart
3. Japanese Candlestick
The focus of this post will be on the Japanese Candlesticks however before we get to candlesticks, we will understand why we don’t use the line and bar chart.
The Line Chart Of Technical Analysis :
The line chart is the most basic chart type and it uses only one data point to form the chart. When it comes to technical analysis, a line chart is formed by plotting the closing prices of a stock or an index. A dot is placed for each closing price and the various dots are then connected by a line.
If we are looking 60 day data then the line chart is formed by connecting the dots of the closing prices for 60 days.
The line charts can be plotted for various time frames namely monthly, weekly, hourly etc. So ,if you wish to draw a weekly line chart, you can use weekly closing prices of securities and likewise for the other time frames as well.
The advantage of the line chart is its simplicity. With one glance, the trader can identify the generic trend of the security. However the disadvantage of the line chart is also its simplicity. Besides giving the analysts a view on the trend, the line chart does not provide any additional detail. Plus the line chart takes into consideration only the closing prices ignoring the open, high and low. For this reason traders prefer not to use the line charts.
I hope you clearly understand why line chart is not important for technical analysis . If you have any query or doubt write down in comment box . Now we discuss about bar chart .
The Bar Chart Of Technical Analysis :
The bar chart on the other hand is a bit more versatile. A bar chart displays all the four price variables namely open, high, low, and close. A bar has three components.
The central line :
The top of the bar indicates the highest price the security has reached. The bottom end of the bar indicates the lowest price for the same period.
The left mark/tick :
indicates the open
The right mark/tick :
indicates the close
For example assume the OHLC data for a stock as follows:
Open – 67
High – 70
Low – 60
Close – 64
For the above data, the bar chart would look like this:
Note the position of the left and right mark on the bar chart varies based on how the market has moved for the given day.
If the left mark, which represents the opening price is placed lower than the right mark, it indicates that the close is higher than the open (close > open), hence a positive day for the markets. For example consider this: O = 46, H = 51, L = 45, C = 49. To indicate it is a bullish day, the bar is represented in blue color.
Likewise if the left mark is placed higher than the right mark it indicates that the
close is lower than the open (close <open), hence a negative day for markets. For example consider this: O = 74, H=76, L=70, C=71. To indicate it is a bearish day, the bar is represented in red color.
The length of the central line indicates the range for the day. A range can be defined as the difference between the high and low. Longer the line, bigger the range, shorter the line, smaller is the range.
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 really hard 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. But if you are starting fresh, I would strongly recommend the use of Japanese Candlesticks. Candlesticks are the default option for the majority in the trading community.
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 actually 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 pattern in candlesticks still retains the Japanese names; thus giving an oriental feel to technical analysis.
Conclusion Of The Chart Types In Technical Analysis :
1. Conventional chart type cannot be used for technical analysis as we need to plot 4 data points simultaneously
2. Line chart can be used to interpret trends but besides that no other information can be derived
3. Bar charts lacks visual appeal and one cannot identify patterns easily. For this reason bar charts are not very popular
We are going to discuss about Candlestick Anatomy in next post . If you have any query or suggestions write in the comment box .
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