Modules for Traders
Introduction to Technical Analysis
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What charts are used in technical analysis.
Technical analysis charts: An overview
Say there’s a stock trading in one of the stock exchanges. Throughout a single trading session, the stock would likely witness innumerable fluctuations, both positive and negative, in its price and volume. In such a case, how do you record such large volumes of data? Sure, you can record all the data in a tabular format, but reading through them would quickly get cumbersome. Here’s where technical analysis charts come in handy.
Technical charts are basically media that represent data in a graphical format. They make it easier to read and draw conclusions from huge volumes of data. Technical analysis charts are so versatile that they can accurately represent the price and volume movement of a share for any specific time period, ranging from one trading day to several years on end.
Charts can help you understand how the price of a stock moved over a particular period of time by plotting four key price points. For a chart that shows the price movements during one trading day, these are the four important points.
- The opening price: It is the price at which the first trade is executed when the markets open up for trading at 9.15 AM.
- The lowest point: It is the lowest price at which a trade is executed in a trading session.
- The highest point: It is the highest price at which a trade is executed in a trading session.
- The closing price: When the markets close for trading, the price at which the final trade for the day is executed is known as the closing price.
The ability to accurately and comprehensively summarise the price action of a stock is the primary reason why technical charts are considered to be the core of technical analysis.
Different types of charts used in technical analysis
Now that you’re aware of the importance of charts, let’s take a brief look at the types of charts that you’ll be typically using for technical analysis.
One of the most basic charts used in technical analysis, the line chart is used to depict the trends in the price of a particular stock or index over a certain period of time. This kind of chart is very useful when it comes to determining the overall trend of a stock. With one look at a line chart, you can identify the price or volume movements of that stock.
Firstly, to plot a line chart, the prices of a stock at different points in time are marked by dots along the horizontal and vertical axis. Here, the horizontal axis represents the time frame and the vertical axis represents the price of the stock. Once that is done, the dots are then connected using a line.
To understand this kind of chart a bit better, let’s look at the 52-week line chart of Infosys Limited.
A bar chart is more useful to a trader involved in technical analysis. It depicts these four price points of a stock for a particular period of time easily.
- The opening price
- The lowest price
- The highest price
- The closing price
A bar chart is generally depicted as a thin central vertical line with two horizontal lines emerging from it, one on the left and one on the right. Here’s how it looks and what the lines mean.
Now that you know what a bar looks like, let’s take an example to understand it better. Say the opening, lowest, highest, and the closing price of a stock are as follows.
- Opening price = Rs. 520
- Lowest price = Rs. 480
- Highest price = Rs. 550
- Closing price = Rs. 535
The bar for the given data would look like this.
Since the closing price of the stock is above the opening price, the stock is said to have moved positively. And, the bar is represented either in blue or in green.
Now, let’s take up another instance where the closing price is lower than the opening price. The stock prices are as follows.
Opening price = Rs. 535
Lowest price = Rs. 480
Highest price = Rs. 550
Closing price = Rs. 520
The bar would then look like this.
Since the stock moved negatively, the bar is depicted in red.
Another point to note when reading through a bar chart is that the length of the bar changes according to the price range. The difference between the lowest price and the highest price of the stock is the price range. Therefore, the longer the line, the larger the range.
For the sake of continuity, we’ll take a look at the 52-week bar chart of Infosys Limited.
The candlestick charts, which first originated in Japan, are what traders involved in technical analysis primarily use. Owing to these Japanese roots, many candlestick chart patterns bear Japanese names like doji and marubozu. We’ll look into the details in the upcoming chapters.
The structure of a candlestick is quite similar to that of a bar chart. The only difference is that the candlestick uses a rectangular body to depict the opening and closing prices of a stock instead of the two horizontal protrusions. Here’s an example of two kinds of candlesticks, depending on whether the opening price is higher or lower than the closing price.
The shadows, also known as tails or wicks, signify the price range of the stock. The longer the shadows, the larger the price range.
Candlesticks and candlestick charts are explained in further detail in the next chapter.
Renko charts, invented by the Japanese, rely on and display only price changes. The origins for the name of these charts can be traced back to the word renga in Japanese, which means bricks. The charts themselves look like a series of bricks arranged in different patterns. Take a look at a Renko chart and see for yourself how the data points are represented by price bricks.
Since Renko charts do away with minor price changes, trend spotting becomes easier. They are also very useful for technical analysis since they help identify support and resistance levels easily.
Heikin Ashi Chart
Another invention from Japan, the Heikin-Ashi chart resembles your regular candlestick chart. The words Heikin Ashi translate to ‘average bar.’ That is because each bar in the Heikin-Ashi chart averages out the prices to create the candlestick that you see on the chart.
Just like your regular candlesticks, the Heikin-Ashi candles also use four data points - the close, the open, the high and the low. But the formulas used for Heikin-Ashi charts are as follows.
Close = 1/4 (Open + High + Low + Close)
Open = 1/2 (Open of the previous bar +Close of the previous bar)
High = Maximum of [High, Open, Close]
Low = Minimum of [Low, Open, Close]
Point & Figure Chart
Often abbreviated as P&F charts, Point and Figure charts make use of Xs and Os to depict data. The Xs indicate an increase in price, while the Os indicate a decrease in price.
See how the Xs and Os are stacked on top of each other? If the price continues to rise, the column of Xs continues to grow. In case the trend reverses, a new column of Os enters the picture. Point and figure charts are useful if you want to determine entry and exit points for your trade.
We’ll get into the details of candlesticks and the chart patterns they form in the upcoming chapter. Learning how to read these chart patterns can help traders like you make sense of price movements easily. Keep reading to find out more.
A quick recap
- Charts are basically media that represent data in a graphical format.
- They make it easier to read and draw conclusions from huge volumes of data.
- Charts can accurately represent the price and volume movement of a share for any specific time period, ranging from one trading day to several years on end.
- There are four key price points plotted in the charts used for technical analysis: the opening price, the lowest price, the highest price and the closing price.
- Charts can be line charts, bar charts, or candlestick charts.
- A bar chart is generally depicted as a thin central vertical line with two horizontal lines emerging from it, one on the left and one on the right. The horizontal line on the left indicates the opening price of the asset, the horizontal line on the right indicates the closing price of the asset. The lowest point in the vertical central line depicts the lowest price of the trading session, while the highest point in the vertical central line depicts the highest price of the trading session.
- A candlestick looks similar to a bar chart, except that it uses a rectangular body to depict the opening and closing prices of a stock instead of the two horizontal protrusions.