Wednesday, September 19, 2012

Basics of Technical Analysis — Charts

Technical analysis is often criticized for its lack of scientific proof, modeling capability, and "abstract" approach to analyzing stocks. While technical analysis on its own may not be very powerful—when combined with other forms of analysis such as fundamental analysis and simulations, it may provide a unique insight into the market.

Today I would like to introduce some basic charts utilized by technicians. We have all seen the standard line chart. The line chart is the most basic chart, as it only takes into account the closing price of the stock for a set period of time. There are advantages and disadvantages to line charts. One of the biggest advantages of the line chart is that it offers a clean, easy-to-see representation of a stock trend. However, there are many disadvantages of a line chart—they do not contain intraday information, high/low information, nor do they show the range that the stock traded during the day.

A line chart.

A second chart often used by traders is called the bar chart. Bar charts alleviate the disadvantages of the line chart by providing high/low information and range information. The top of the bar chart represents the high for the stock during the day, and the bottom of the bar represents the low for the stock. The horizontal line to the right of the bar represents the closing price. Sometimes, there is also a horizontal line to the left of the bar—this represents the opening price.

A bar chart.
Source: TradeStation

The third and final chart that I would like to cover is the candlestick. The candlestick chart was invented in Japan and was used as early as the mid-1600's to trade rice futures. A candlestick chart offers the same information as the bar chart, but a candlestick chart always includes the opening price. The actual "candlestick" is called the Real Body and what looks like a wick extending out of the candlestick are called shadows. The candlestick is shaded white (or green) to indicate a day where the stock closed higher, and black (or red) to indicate a day where the stock closed lower.

How to read a candlestick.
A candlestick chart.
Source: TradeStation

By utilizing a variety of different charts, you can gain a much better understanding of intraday price movements. Additionally, it is easier to see large price movements and the momentum of a specific stock by observing ranges and high/low information—both of which can be observed in charts like the candlestick and bar charts.