The Significance of Trading Charts

[San Anderson 1]

 

Underlying every trading decision is a slice of data. Charts are the graphic presentation of that data, providing a visual way of gauging and interpreting price action over time. Traders rely on charts, for with them, the prices' movements, trends, and further potential are more directly brought out based on past data.

It would be next to impossible to tell at one glance whether an asset is trending higher or lower, becoming volatile, or heading towards major support and resistance levels without charts. To the day trader and the long-term investor, the art of reading the charts can make a difference between profit and loss.

Types of Trading Charts

Before diving into specific strategies and techniques, it is important to understand the various chart types available. Since each chart type will offer you a different perspective on market data, choosing the right type will be critical to your trading strategy.

1. Line Charts

The line chart is one of the simplest and best-known chart types. It draws a single line based upon an asset's closing price over a specified time period. Line charts are great to identify overall or big picture trends, but they do not have enough information for detailed technical analysis.

Pros:

Simplicity. It is easy to read and understand.

Gives a good overview of the direction of a trend.

Cons:

Does not depict intraday price movements like highs, lows, and opening prices.

Lack of depth in regard to advanced technical analysis.

2. Bar Charts

The bar chart, also referred to as the Open, High, Low, Close chart, is similar to a line chart but reflects open, high, low, and close of an instrument for chosen periods.

Each bar comprises:

The top of the bar: the highest price;

Bottom of the bar: the lowest price.

The horizontal tick to the left represents the opening price, and the horizontal tick on the right represents the closing price. 

Advantages

Line charts provide more detailed price information compared to charts.

Due to their nature, they are very helpful for the activity of identifying market trends and patterns. 

Disadvantages

Difficult to read for beginners because of the amount of information presented. 3. Candlestick Charts Candlestick charts are the most popular among traders in that they provide a complete representation of price action. Like bar charts, candlesticks show the open, high, low, and close of an instrument for a selected period. The only difference is in its appearance: the candlesticks have a "body" which is colored and it visually represents the area between the open and close price. If the close is higher than the open, then the body is usually colored green or white. If the close is lower than the open, the body is red or black.

Pros:

Visually attractive and easy to read.

Critical information is given in a compact form.

It's practical for the reversal and the continuation patterns.

Cons:

Mostly too much information for a complete beginner to digest.

3. Heikin Ashi Charts

Heikin Ashi charts are a form of candlestick chart that smooths the price action to identify the trend. Heikin Ashi candles are calculated with an averaging method other than that in traditional candlesticks, which makes them noisier and more oriented toward the main market direction.

Advantages:

Excellent for trading according to trend-following strategies.

Reduces market noise by not responding to fake signals.

Disadvantages:

Not efficient in perfect timing of trade compared to the usual candlestick chart.

Lags from price action due to averaging.

Renko charts are built by placing a brick in the next column when the price goes over a pre-defined value called the box size. It is also said that Renko ignores time and only gives importance to price movement; hence, Renko charts serve as very efficient trend-determination tools for filtering out market noise.

Pros:

Excellent in the identification of key trends and price levels.

Gets rid of little noise or choppiness in price.

Cons:

It can become challenging to understand for complete beginners.

It does not suit short-term or intraday traders.

Key Charting Tools and Indicators

While charts themselves give lots of valuable information, many traders use technical indicators to further enlighten themselves regarding market behavior. The indicators are mathematical calculations based upon the price, volume, or open interest applied to chart data with the view to predict probable movements in price. Some of the popular indicators used by traders follow:

1. Moving Averages

Moving averages are used to smooth out price data in a curve that makes it easier to determine the trend of the market. There are, in short, two major types:

Simple Moving Average: The average of the prices over a selected number of periods.

Exponential Moving Average: Similar to SMA, but weights recent prices higher, thus it is more responsive to new information.

How to Use Moving Averages:

Crossover strategy: When a short-term moving average crosses above a long-term moving average, this situation can be interpreted as a potential buying opportunity, or what is more commonly referred to as a bullish crossover. Conversely, when a short-term moving average crosses below a long-term moving average, this can be looked upon as a potential selling opportunity otherwise known as a bearish crossover. Support and resistance: Moving averages may also serve as dynamic levels of support or resistance. 2. Relative Strength Index (RSI)

One of the indicators belonging to the oscillator family of momentum is called the Relative Strength Index. It maps out the velocity and magnitude of change in prices. The velocities range from 0 to 100, with overbought readings occurring over 70 and oversold readings occurring below 30.

Using RSI:

Overbought/Oversold Conditions: When the RSI enters the overbought zone-that is, above 70-it could indicate that the asset is overvalued and due for a pullback. From another perspective, when the RSI slips below 30 and enters the oversold territory, this could indicate that the asset has become undervalued and may be presenting a buying opportunity.

Divergence: When the price creates a new high or low but does not get confirmed by the RSI, such a scenario creates RSI divergence and usually signals a potential reversal.

Bollinger Bands

Bollinger Bands consist of three lines: a simple moving average-the middle band-and two outer bands plotted two standard deviations away from the moving average. The bands expand and contract based on volatility. This characteristic makes them useful for determining either a time of low or high volatility.

How to Use Bollinger Bands:

Squeeze: When the bands come closer together, that means that volatility is low and may be ready to break out.

Mean reversion: The price often touches or violates the outer bands and then returns back to the middle band, providing potential entry or exit signals. 4. Fibonacci Retracement

Fibonacci Retracement: A study used to determine levels of support and resistance by drawing horizontal lines based on the Fibonacci series. Traders find these levels helpful because they serve as an indication of where to expect the market to pull back or rally.

How to Use Fibonacci Retracement:

Support and Resistance-Fibonacci levels can be used for support and resistance in trending markets during retracements.

Entry points: Traders regularly use Fibonacci retracements to measure likely entry points to trade in the direction of the whole trend.

Chart Patterns and Price Action

In addition to indicators, traders also use chart patterns as methods of determining what might occur with prices in the future. These are visual patterns that form on a chart because of price action and usually occur with potential breakouts or reversals in a trend or the continuations of trends themselves. A few common patterns include:

1. Head and Shoulders

It is a trend reversal pattern that signals a possible trend shift. It has three peaks-it consists of a middle peak known as the head, which is higher than the two other side peaks, referred to as shoulders. A break below the neckline (support level) confirms the pattern and suggests a trend reversal.

2. Double Top and Double Bottom

The double top is a bearish reversal pattern that occurs after an uptrend and is, for the most part, constituted of two peaks occurring around the same level. A penetration of the support line confirms the pattern. The double bottom is a bullish reversal pattern that forms after a downtrend and has two troughs formed at approximately the same level.

3. Flags and Pennants

Flags and pennants are a continuation pattern that reflects the consolidation of a brief nature before resuming into the previous trend. A flag comes out as a little rectangle against the slope of the trend while a pennant is a tiny symmetrical triangle.

Conclusion

Trading charts are a fabulous gadget for both amateur and accomplished traders. By first understanding chart types, indicators, and patterns, the trader can go on to make informed decisions and hopefully increase their chances of success in the markets. Charting is not an exact science; neither should it be used in isolation, but the art of reading a chart certainly forms a major ingredient of any trader's development. Whether this involves trading in stocks, forex, cryptocurrencies, or commodities, a full understanding of charting techniques will go a long way toward endowing a trader with a real edge in the intricacies of financial markets.