The trader can use charts to trace and analyze the market. This kind of analysis requires developed chart reading skills.
Let’s take a look at the most popular chart types.
This type is the simplest and the most important. It is made of connected dots, each representing a closing price over a certain period. This kind of chart helps to recognize trading trends, as well as support and resistance levels. Technical analysis usually requires a great deal of information that is not shown in the line chart, that is why this type of chart is less suitable for in-depth analysis. For instance, the linear chart cannot provide any estimate of what was happening during a trading period (if prices were dropping or growing dramatically, or what was the relation between the price range and the closing price). On the other hand, if a trader doesn’t use that information, the absence of it on the chart can be seen as an advantage. Line charts are also convenient for figure analysis trading, because they show price momentum without any unnecessary parameters.
They are also known as interval histograms charts, and look like this:
Each trading period on the chart represents the following information:
Let’s give an example of 1-hour period. The vertical line on the bar chart shows the given hour’s price range (the range within which the quotations were changing). The lowest point of the vertical line is the minimal price within a period, while the top point shows the highest price. The line on the left shows the opening price (the price in the beginning of the period); in this case it will be the price in the beginning of the hour. The line on the left shows the closing price (the price in the end of the period); in this case it will be the price in the beginning of the hour.
If the bar chart shows that the opening price was higher than the closing price, it means that the price dropped within a given period. In the opposite case we are observing growth. Though bar charts show the range of price changes on a given period, they give no information on how exactly the price changes took place in this period. This information can be obtained if you switch to shorter periods.
A Japanese candlestick chart looks like this:
Though Japanese candlestick charts are similar to bar charts, they are widely considered as more convenient for visual reading. Just as bar charts, they show the minimum and the maximum price within a period, while the candle body shows the opening and the closing price.
The candle’s body is filled depending on the relation of the opening and closing price. Traditionally the rule is as follows: if the opening price is higher than the closing price (i.e. the price drops on a given trading period), the candle body is filled with a dark color; if the opening price is higher than the closing price (the price rises on a given trading period), the candle body is filled with a light color, or left empty.
Note: most technical analysis programs allow changing candle body colors, that’s why other combinations are also possible, e.g. red and green, etc.
The distance from the candle body to the maximum price is shown as a vertical line, which is called the candle’s upper shadow.
The distance from the candle body to the lowest price is also shown as line, and called the candle’s lower shadow.
Just as bar charts, Japanese candlestick charts don’t show how exactly the price was changing in a given period – it just shows the maximum/minimum price fluctuation.
Trend is a general direction in which price waves are moving. Trends are not necessarily linear; they consist of a number of market moves. In the end the trend weakens, which can be seen as a bounce off.
There are two possible directions in which the diagram can move: up/down and sideways. We define trends by observing peaks and valleys.
Up trend: – the equity’s peaks and valleys are gradually getting higher.
Down trend: – the equity’s peaks and valleys are gradually getting lower.
Sideways trend: – the equity’s peaks and valleys are more or less the same.
We can also use the trend’s angle to define its power (the steeper the angle, the stronger the trend).
Technical analysis is based on finding support and resistance levels, which surround the price movements like a floor and a ceiling.
Support level is the price level on which the equity’s price stops dropping; after that it changes direction and starts growing. The support levels are represented on a diagram by a horizontal or mostly horizontal line connecting several valleys.
The more valleys there are on the same price level, the stronger the support level is. As a rule, if a support level is too strong, one can expect a change in direction, and the price will continue moving to a different trend.
Resistance level is the price level on which the equity’s price stops growing; after that it changes direction and starts dropping.
The support levels are represented on a diagram by a horizontal or mostly horizontal line connecting several peaks.
The stronger the resistance level gets, the higher is its probability of being broken.
The beginning of a powerful price move is a suitable moment for entering a trade.
The more detailed descriptions and examples of this kind of analysis can be found in the strategies section.