Part 4 of the Technical Analysis classroom tells you how to read candlestick charts and trendlines to understand the price data.
Q. Like price to earnings multiple for fundamental analysis, is there any indicator that is most important in technical analysis?
A. Indicators are additions on charts that provide extra information through mathematical calculations on price and volume.
Since all the indicators are based on two basic things, the most important thing in technical analysis is the price and volume data.
Price and volume data helps you understand the trend and momentum of the stock or the commodity. Apart from the basic price and volume data, indicators like moving averages, RSI, Fibonacci retracements are important in technical analysis
Q. What is a line chart? What is its significance?
A. A line chart is a representation of the historical price of a security. This is the most basic type of chart used in technical analysis which depicts the closing price of a security over a period of time.
A line chart is easy to understand as it gives clear visibility of the price movement over a given period. Line charts exclude data such as high, low and open prices, which helps to reduce the noise.
Using a line chart helps a trader to easily identify key supports and resistance and the also price trends
However, if a trader needs more information than a closing price, a line chart would be a limitation
Q. What is the bar chart? What is its significance?
A. A bar chart is a graphical representation of OHLC data i.e. open, high, low, close. Each bar is a set of four prices for a given time frame connected to a bar and is known as a price bar.
The left horizontal line represents the opening price
The right horizontal line represents the closing price
Top of the bar represents the high price and
Low of the bar represents the low price
A bar chart can be used for periods shorter than a day. Since bar charts contain more information than a line chart, one can get a lot of information from a bar chart depending on the size of the bar, the colour of the bar etc.
Q. What is a candlestick chart? How is it different from a bar and line chart?
A. Candlestick is a type of price chart that displays the same OHLC data. It consists of a body and a shadow. While the body denotes the open and close data, the shadow denotes the high and low price. Candlesticks are separated on the basis of the colour of the body. When the close is higher than the open, it is a bullish candle which has a green or white body. When close is below open it is a bearish candle which has a red or black body.
Candlesticks are formed in many different shapes and sizes. Each of them is unique and denotes something about the market condition. These are known as the Candlestick pattern.
While line charts just show data of closing value, Bar charts and Candlestick charts show the same information but in different ways. A bar chart consists of vertical and small horizontal lines on left and right, which denote the open and close values. However, in a candlestick chart, the open and close values are denoted by a body instead of a small horizontal line.
Q. While following charts, can I look at anyone of them, or do I have to look at all the three - line, bar, candlestick?
A. Most used out of all three types of charts is candlesticks. Though bar charts and candlesticks give the same information, candlesticks are much more easy to understand and interpret as compared to bar charts because candles are clearly visible than bar
Line charts, however, contain information about only the closing value. Hence, a longer-term view on a line chart gives a clearer picture than a candlestick chart. On a smaller time frame, candlestick gives an in-depth view of the chart as compared to a line chart
Depending on one’s need, one has to use only one type of chart and not all three.
Q. What is a trendline in the context of technical analysis?
A. Charles Dow stated that the price of a security moves in a trend. Trends are often identified by what is known as trendlines. A trendline is drawn by joining two or more important points (peaks or troughs) on a chart.
Once a trend is formed it remains intact until broken. Trendline helps understand the direction of the market. We have four data points (OHLC), by using them one can draw a trendline. One can join two important highs or close and in a similar manner join two important lows or close to get a trendline.
Trendlines can be used by traders to find potential areas of support and resistance. The strength of trendline increases as prices take the support or resistance at the same trendline
Q. What is an uptrend? How do you identify it?
A. An uptrend is a rising trend where the price movement of the asset is in an upward direction. It is composed of higher highs and higher lows i.e. each successive peak and trough is higher than the previous peak and trough.
A rising trendline helps to identify such uptrend by joining two or more swing lows which would help to identify where the future swing low will form. An uptrend can also be identified based on moving average i.e. when price trades above the moving average the stock is in an uptrend
In an uptrend, a trader buys at or near the trendline support or moving average support in expectation of a stock price to maintain the uptrend and respect the support levels.
Q. What is a downtrend? How do you identify it?
A. A downtrend is a falling trend where the price movement of the asset is in a downward direction. It is composed of lower highs and lower lows i.e. each successive peak and trough is lower than the previous peak and trough.
A falling trendline helps to identify such downtrend by joining two or more swing highs which would help to identify where the future swing high will form. A downtrend can also be identified based on moving average i.e. when price trades below the moving average the stock is in a downtrend.
In a downtrend, a trader sells at or near the trendline resistance or moving average resistance in expectation of a stock price to maintain the downtrend and respect the resistance levels
Q. What is a sideway trend? How do you identify it?
A. A sideways trend is a horizontal price movement when a security trades between a price range. It is composed of similar highs and similar lows i.e. each peak and trough is at the same level as the previous peak and trough.
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