An Overview of Chart Types Used in Technical Analysis
One of the main methods used by technical analysts to forecasting security prices is by the recognition of patterns and trends of security prices, and the easiest way to spot patterns and trends is through the use of charts. In fact, the use of charts is so prevalent, that technical analysts are often called chartists. Originally, charts were drawn by hand, but most charts nowadays are drawn by computer.
Charts are graphical displays of price information of securities over time. Often, such charts also show volume. Besides allowing the technical analyst to easily spot patterns and trends, the main benefits of charts are the concise presentation of price and volume information over a duration, which can be used by fundamentalists to study how the market has reacted to specific events. Market volatility can also be easily gleaned from charts. Charts also help technical analysts to decide on entrance and exit points, and at what prices to place stops to reduce risk.
The main chart types used by technical analysts are the line chart, bar chart, candlestick chart, and point-and-figure charts. Charts can also be displayed on an arithmetic or logarithmic scale. The types of charts and the scale used depends on what information the technical analyst considers to be most important, and which charts and which scale best shows that information.
Chart Scales: Arithmetic and Logarithmic
Most charts display price intervals on the vertical axis and time intervals on the horizontal axis. A chart based on the arithmetic scale (aka linear scale) shows the same distance between equal price differences. So if a chart had $10 price intervals, then each interval is the same length on the vertical axis. So a $10 stock that increased by $10 would be plotted up by the same amount as a $100 stock that increased by $10, even though the $10 stock doubled in price while the $100 stock only increased by 10%.
The logarithmic scale (aka semi-logarithmic scale) uses percentages as the primary unit rather than absolute differences. On a logarithmic scale, a $10 stock increasing by $10 would plot higher than a $100 stock rising by $10. Hence, a chart based on a logarithmic scale presents price change information more accurately than a chart based on an arithmetic scale. A chart based on the logarithmic scale can also cover a wider range of prices than a chart of the same size based on the arithmetic scale. However, if the price range displayed in the graph is narrow, then there is little difference between the 2 scales.
Line charts are the simplest form of charts depicting price changes over an interval of time. Usually, only the closing price is graphed, depicted by a single point. The series of these points constitutes a line — hence, the name. However, intraday price changes can also be plotted, either by plotting each trade, or by selecting the last price of a given interval, such as an hour or 15 minutes. Because line graphs are simple, it is easier to compare the prices of multiple securities or indexes on the same graph.
The line chart also shows trends the best, which is simply the slope of the line.
One of the basic tools of technical analysis is the bar chart, where the open, close, high, and low prices of stocks or other financial instruments are embedded in bars which are plotted as a series of prices over a specific time period. Bar charts allows traders to see patterns more easily. In other words, each bar is actually just a set of 4 prices for a given day, or some other time period, connected by a bar in a specific way — called a price bar.
A price bar shows the opening price of the financial instrument, which is the price at the beginning of the time period, as a left horizontal line, and the closing price, which is the last price for the period, as a right horizontal line. These horizontal lines are also called tick marks. The high price is represented by the top of the bar and the low price is depicted by the bottom of the bar.
Another type of chart used in technical analysis is the candlestick chart, so called because the main component of the chart representing prices looks like a candlestick, with a thick body, called the real body, and usually a line extending above and below it, called the upper shadow and lower shadow, respectively. The top of the upper shadow represents the high price, while the bottom of the lower shadow represents the low price. Patterns are formed both by the real body and the shadows. Candlestick patterns are most useful over short periods of time, and mostly have significance at the top of an uptrend or the bottom of a downtrend, when the patterns most often signify a reversal of the trend.
While the candlestick chart shows similar information as the bar chart, certain patterns are more apparent in the candlestick chart. The candlestick chart emphasizes opening and closing prices. The top and bottom of the real body represents the opening and closing prices. Whether the top represents the opening or closing price depends on the color of the real body — if it is white, then the top represents the close; black, or some other dark color, indicates that the top was the opening price. The length of the real body shows the difference between the opening and closing prices. Obviously, white real bodies indicate bullishness, while black real bodies indicate bearishness, and their pattern is easily observable in a candlestick chart.
Point-and-figure charts list only significant price information as columns of X's and O's without regard to time, so that trends, resistance and support levels are more apparent. Although time is depicted on the horizontal axis, the units of time are determined by when the trend changes.
There are several ways of constructing point-and-figure charts, but all are based on box size, which is the minimum price differential necessary before a price is recorded as an X or an O. Columns of X's show an uptrend, and O's show a downtrend. Generally, closing price differentials are used. There is no high, low, opening, or closing prices recorded, since only the change in price greater than the box size is recorded as an X if the price differential is up or as an O if it is down. Each consecutive X is recorded in the same column above the previous X until the price reverses by more than the box size, then a new column is started by recording an O in a box below and to the right of the highest X in the previous column. O's are added downward with each price decrease greater than the box size until the downtrend reverses to an uptrend, starting a new column where the 1st X is placed in the box above and to the right of the last O in the previous column.
For example, if the box size is considered 1 point, then if XYZ stock rises from 10 to 11, it is recorded as an X because the price rose by at least 1 dollar. If the stock rose only $.50, then it would not be recorded since the price increment was not at least the box size of 1 dollar. If the price increased by at least 1 dollar the next day, then another X would be recorded above the previous one in the same column. If the next day, the price declined by $.25, then nothing would be recorded, since the change is less than the box size. If on the following day, the price declined by more than 1 dollar, then a new column of O's would be started with the 1st O recorded 1 box below the top X of the adjacent column. Each time the price declined by more than the box size, then another O would be placed below the last O of the column. When the stock rises by more than the box size, then a new column of X's would be started, with the 1st X placed 1 box above the bottom O of the adjacent column. Note that, except for the first and last columns, each X column is flanked by O columns, and vice versa.
The construction of point-and-figure charts simplifies the drawing of trend lines, and support and resistance levels, which is why point-and-figure charts are ideal for detecting trends, and determining support and resistance levels.
This seems to be the most common type of point-and-figure chart, but keep in mind there are several variations that differ significantly from the above description.