Line chart is the most basic chart used in technical analysis. It is often used by analysts to quickly gauge the market price, as it is very simple to see how the price changed over time. It is constructed by connecting the closing prices for each period over a chosen time frame. Users can also choose to calculate the line based on opening, highest or lowest prices, but closing prices are used most often.
Bar chart does offer more information than line chart and because of that, it is more popular between traders. Bar chart gives us information about opening and closing price, as well as lowest and highest price reached for the chosen time frame. Each bar represents period of time based on our chosen time frame. For example one hour time frame means, that each bar represents information about price movement over a period of one hour. Each bar has two horizontal dashes that show opening and closing prices. Left dash represents opening price and right one closing price.
Candlestick chart was developed back in 18th century in Japan by rice trader Munehisa Homma. Since then it has become very popular since it is simple, yet powerful tool for analyzing markets. Construction of candlestick chart is similar to bar chart, but the individual bars are in form of “candlesticks”. Candlesticks are made of body and wick. Body of a candlestick represents price range between opening and closing prices. Wicks of a candlestick show the highest and lowest price reached over a chosen time frame. Based on colour of the candlestick we can see whether the price ended up higher or lower at the close of a candlestick. Most commonly used colour combinations are red and green or black and white, where green/white colours show that closing price is above the opening price, thus indicating rise of price over a period of chosen time frame. Black/red colours show that closing price is below the opening price, indicating decline of price.
Although candlestick chart might look complex in the beginning, it can be very useful tool if understood correctly. Traders realized this long time ago and created many different candlestick patterns that can be used to predict future price movement. These patterns consist of one or few specifically looking candlesticks. They can provide powerful signals, but it is recommended to use candlestick patterns in combination with other tools of technical analysis. They usually represent a reversal signals that can cause turn in trend and with combination with other tools can offer great trading opportunities.
It would be good to follow this also to say a little about trends and timeframes:
Successful technicians always look for trends in the marketplace. Trends represent imbalance in orderflow and thus trading in the direction of prevailing trend offers higher probability opportunities in comparison to counter-trend trading. “Trend is your friend” is well known saying among technical analysis traders. Trends can last for a long time and we can never know when the trend is going to change. Trying to predict turning point of well established trend is much more difficult and often less profitable than trading in the direction of the trend.
There are two types of trends: bullish and bearish trend. Bullish trend, also called uptrend, indicates continually rising prices of certain instrument. On the other hand bearish trend, also called downtrend indicates continually declining prices. Existence of trend does not mean, that price is going to rise/decline in a straight line. Even if there is well established trend, price ebbs and flows, creating a series of highs and lows. Uptrend would then be defined by continually making higher highs and higher lows.
Timeframes and trends
Based on preferred trading style, traders choose time frame from which they analyze market. In modern trading platforms, charts can be displayed on many different time frames. Chosen time frame shows price movement during that time period represented by single bar or candlestick. Taking time frames into consideration when identifying trends is important, because type of trend can differ across different time frames. For example an insignificant pullback on daily time frame can look like a major trend on lower time frame. Following charts show the difference in prevailing trend between daily and one hour time frame. If we look at the grey box illustrated on the daily time frame chart from the perspective of hourly time frame, we can see that what looks like a simple pullback in a major uptrend on daily time frame, is actually a bearish trend on the lower time frame. Using different time frames when analyzing markets helps traders to gauge the overall context and make more informed decisions.