Introduction to Charts for the Beginning Technical Analyst

This is an introduction to charts and how to read them for beginning technical analysts. Technical analysts are investors who utilize technical analysis when conducting investment, focusing on price movements rather than on a company’s fundamentals. Fundamental analysts use fundamental analysis as an investment approach, which focuses on a company’s income, price-earnings ratios, assets and other indicators, unlike technical analysts. Technical analysts use charts to examine securities and forecast price movements. For the total beginner, “securities” refers to any tradable financial instrument such as stocks, bonds, futures or market indices, and other financial devices. Any security with data over time can be used to form price charts. Because charts provide a graphical representation of a security's price movement over time, they are also of use to fundamental analysts as well. A historical graphical record makes it simple to study the effects of events on price, performance over a period and a security's actual trading near highs, lows, or in between. The timeframe used for the chart varies according to the compression of the data: intraday, daily, weekly, monthly, quarterly or even annual data are the major timeframes commonly utilized.

What are the different kinds of data? Daily data is made up of intraday data that is compressed to show each day as a single data point, and weekly data is made up of daily data that is compressed to show each week as a single point. The shorter the timeframe and the less compressed the data, the more detail available. However, short-term charts can thus be volatile and contain a lot of “noise”, where noise is basically a distortion of the actual patterns or trends by events that are not important to the analysis. Large sudden price movements, wide high-low ranges and price gaps can affect volatility, which distorts the big picture. Investors usually focus on weekly and monthly charts to spot long-term trends, and because long-term charts cover a longer time frame, price movements do not appear as extreme and there is less noise. Some technical analysts use a combination of long-term and short-term charts, where long-term charts are good for technical analysts analyzing the big picture to get perspective of historical price action. Once the picture is examined, then a daily chart can be utilized next to focus closely on the last few months.

There are many charting methods, such as bar charts, line charts, candlestick charts, among other charting methods. The most popular charting method is the bar chart, in which the high, low and close are needed to form the price plot for each period. Bar charts can be effective for displaying a large amount of data. For example, line charts show less clutter, but do not offer as much detail. There are also candlestick charts. Candlestick charts are also rather popular nowadays. For a candlestick chart, the open, high, low and close are all presented. Many traders and investors believe that candlestick charts are easy to read, especially the relationship between the open and close.

 

Now for yet more technical words and technical aspects of technical analysis: There are two methods for showing the price scale along the y-axis: arithmetic and logarithmic methods. An arithmetic scale displays 10 points as the same vertical distance regardless of the price level. Each unit of measure is the same throughout the entire scale. A logarithmic scale measures price movements in percentage terms. However, arithmetic scales on the other hand are useful when the price range is confined within a relatively tight range. Arithmetic scales are useful for short-term trading. Price movements are shown in absolute dollar terms and reflect movements dollar for dollar.

In the final analysis, even though many different charting methods are available to the analyst, one charting method is not necessarily better than another technique. Why? The data is the same but you can see that each technique does provide its particular interpretation, with its benefits and disadvantages. The data is the same, hence, price action is what counts. Therefore, it is the examination of the price action that separates successful technical analysts from unsuccessful ones, and after all, that is the key to technical analysis. The choice of which charting technique to use will depend again on individual preferences and either personal trading or investing styles. Once you have chosen a particular methodology it is best to stay with it, and develop how best to read the signals using that method. Switching to other methods may cause confusion and destroy the clarity of your analyses, leading to bad evaluations. More investment research and education will definitely help you. Good luck with your technical analysis education and investment future.