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Charts in Technical Analysis
Technical analysis is a very interesting subject. It is not a definitive science, rather probabilistic discipline. Simply saying it is more of an art than science. Technical analysis is all about getting the price right at right time. Analysis of market trends is the first tool that is used in technical analysis. However, trend analysis cannot be done without historical data regarding price and volume. A technical analyst only looks at price of the financial asset as a result of supply and demand interaction. For him, price is supreme because every fundamental reality is manifested by price. Charts and chart patterns along with other tools help a trader to develop an extra edge on the market assessment. It is in this connection it is essential to understand what is chart and how chart patterns help.
Trying to perform technical analysis without using charts is like trying to build a house without owning land. Let us try to understand what chart of any financial asset or a security is.
To put in the simplest term, 'chart' is a graphical representation of price over time. Historical data based on a combination of price, volume as well as time are plotted on charts. There are many types of charts available. But most popular and widely used among them are Line Charts, Bar Charts and the Candlestick Charts. The horizontal axis of the chart represents the historical time periods while the vertical axis displays the price or volume corresponding to each period. The unit of time period can be year, month, week, day, hour or any number of minutes. The most important feature of time in technical analysis is that the same concepts can be applied to charts irrespective of time frame of observation. Generally, higher the time frame of the chart, higher is the probability of any concept in the market.
Line Chart :
In line chart each and every price point is represented as a dot. The horizontal X-axis represents the time scale while vertical Y-axis represents the price. Each dot represents the closing price at the end of a unit of time. These points are then joined to form a line. Line charts give clear as well as simple general idea of the price movement's direction in the market. But this kind of chart doesn't provide much insight into intra period price movements (like open, high, low etc.)
Bar Chart :
As compared to line chart, bar chart is much more informative. Instead of plotting a dot, in making bar chart, a vertical line (bar) with two horizontal dashes protruding out of it on either side is drawn for particular unit of time. The top end of each vertical line signifies the highest price while the bottom end signifies the lowest price occurred during the time period. The horizontal dash on the left side of the vertical line represents the open price while the horizontal dash of the right side of the line represents the closing price. Thus each mark on a bar (vertical line) tells us about open, high, low and close variables.
If the opening price is lower than the closing price, the bar is colored green and if the closing is lower than the opening price, the bar is colored red. As a result, one can easily grasp the direction of the price movement by observing bar chart.
Candlestick Chart :
Candlestick charts were originated in Japan before about 200 years by a Japanese man named Homma who discovered that there was a link between price and the demand-supply of commodity like rice, and hence markets also were strongly influenced by the emotions of the traders.
It is called as candlestick chart because the main component of the chart which represents prices looks like a candlestick, with a thick ' rectangle body' and a line extending above and below it, called the upper shadow and lower shadow respectively.
In Candlestick chart of a particular time period, each candlestick shows open, high, low and close price of the security for that relative time period. The candlestick's wide or rectangle part is called "real body" which shows the link between opening and closing prices. Thus real body shows the price range between open and close for that particular time frame.
When the real body is filled, black or red then it means that the close price is lower than the open price and it is known as bearish candle. It shows that the prices opened, but the bears pushed the price down and closed below the opening price.
If the real body is empty, white or green then it means that the close was higher than the open price and it is known as bullish candle. It shows that the prices opened, the bulls pushed the price upward and closed higher than the opening price.
The thin vertical lines above and below the real body is knows as the wicks or shadows which represents the high and low of prices during the trading session.
The size and position of the real body along with the length of the upper and lower shadow in candlestick gives many more information about price movement. By observing a single candlestick or two or three consecutive candlesticks, traders can easily grasp knowledge about conviction or reversal in price movement.
Chart Pattern
A chart is a visual representation of past and current price movement of a security. Chart Pattern recognition is one of the most popular methods of technical analysis. In technical analysis it is believed that the collective behavior of all the participants in market accurately reflects all the relevant information and the price movement reflects the impact of this collective behavior. It signifies collective behavior of human nature about price of security and helps to suggest what would be the next possible move. In general, chart pattern helps in finding out who is going to win the battle of price between bulls and bears.