Technical Analysis Charts – An Introduction

A stock’s chart is a visual display of a stock’s price information mapped over a period of time. The prices are plotted on the Y-axis (vertical scale) and the timeline is represented on the X-axis (horizontal scale). This is how a typical stock’s chart would look like (Click here for a larger image):

Lehman Brothers weekly chart

Technical analysts use these charts for studying a stock. By applying standard technical indicator formulae, they evaluate the stock’s movements and predict whether its price will move upwards or downwards. Based on these results, the analyst either enters into a trade himself or recommends a course of action to his investor/trader clients.

Fundamental analysts too refer to these charts to follow a stock’s history of its price trend. The price trends are then reconciled with any key events (announcements, economic news, budget changes) in the stock’s life and an investment strategy is formulated based on the data gathered.

The significance of timeframes on a chart

You have seen the chart above – now notice its timeframe, it spans over a 12-month period. There is a data point that is plotted for very single day and this data point can be represented by a dot, bar or candlestick – the longer the period of the chart, the more the details, and vice versa.

An important factor to note is that data points are compressed for charts that cover a vast timeframe. So, if you have to view data for a period spanning 2 years, it would be impractical to view daily data – in such cases the daily data points are compacted (by averaging) and converted to weekly data points.

Here is how different classes of traders use charts:

  1. Day and swing traders are interested only in daily or weekly charts. They study the charts as the prices fluctuate during a session. They are not interested in the previous data.
  2. Short- to medium-term traders typically study charts that cover 1–6 months of a stock’s price action.
  3. Long-term traders study charts that span a few years, say, 1–4 years. These charts carry compacted (weekly/monthly) data points.
  4. As explained above, fundamental analysts reconcile charts that cover a longish period with key events impacting the company, and then devise an investment strategy.

Once the short-term and long-term traders understand a stock’s price movement over a certain period, they shift their focus to weekly charts because they have already understood the technical traits of the stock and are familiar with its historical response to a set of indicators.

What do charts say?

To a person who knows even a little about technical analysis and indicators, chart formations can look like a treasure trove. They can indicate the following:

  1. Which way is the market or stock or that sector headed – up or down.
  2. Accumulation in a stock.
  3. Support and resistance levels of a stock, which if broken can take the stock downward or upward, respectively.
  4. Whether the stock’s volumes justify its price.
  5. Time to sell.
  6. Time to buy.
  7. Time to leave a stock alone.

Popular types of chart formations

Line Chart Formations

Line chart formations are used for technical analysis of stocks that are thinly traded, for technical analysis of indices, and for watching intra-day stock fluctuations. Analysts plot either the opening, high, low, average or closing data of a stock/index on charts. Technical purists do not think much about these charts because the data points do not take into account the stock’s volatility in a session. (Click here for a larger image)

Lehman Brothers weekly line chart

Bar Chart Formations

Each data point in a bar chart formation talks about the high, low and close of a stock. The high and low price points are represented by a vertical line, while the close is represented by a smallish horizontal line that cuts through the vertical line at the point that represents the closing. Some analysts also prefer to plot the opening price – in this case, there is no strikethrough in the vertical line. Instead, the opening price is represented by a small horizontal line that joins the vertical line on the left, while the closing is represented by a small horizontal line that joins the vertical line on the right.

Bar chart formations are very popular because not only do they display a whole lot of details, they present these details in a very lucid way. Bar chart formations look neat and free of clutter. Here is how a typical bar chart formation looks like (click here for a larger image):

Lehman Brothers weekly bar chart

Candlestick Chart Formations

These chart formations were invented in Japan over 300 years ago and are now becoming quite popular with technical analysts. They take into account an amazing range of details – opening, high, low and closing prices. They are considered easy to read, but one needs an entire article to explain them exhaustively; so stay tuned for a forthcoming feature on Candlesticks. (Click here for a larger image):

Lehman Brothers weekly candle chart

Well, this is what a beginner needs to know about charts. The next feature will deal with support and resistance levels.

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