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Stock charts detail the historical price movements of a stock. Most charts also show the volume traded in each time period. It is from stock charts that all the information to perform technical analysis can be found.
The chart shown outlines the main features found in a stock chart. The example shows the stock BHP Ltd. (BHP) trading between the 1st December and 7th June.
Price: This is the dollar value at which the stock traded. In this particular example, it shows the closing price for each time interval. By joining all the closing price points, a line is formed. This is called a line chart.
(The closing price is the last price that is traded for a particular time interval).
Time: The time interval can be shown in seconds, minutes, hours, days, weeks, months, years or any time interval that may be of interest. In this particular example, the time is shown in days so that a closing price is shown for every day that the stock traded. In a weekly line chart, each time interval would be one week and each time interval would show the closing price of the stock at the end of every week.
Volume: The volume shows the amount of stock (number of shares) that traded for that particular time interval. In the example, the volume bars show the number of BHP shares traded each day.
The highlighted day in the chart shows that BHP closed at $12.10 on the 28 March, 2004. ($12.10 is the closing price because it is the price at which the last trade for the day was executed).
Technical analysts are often interested in more than just the closing price. The opening price is the first price that is traded for a particular time interval. The low price (or 'low') is the lowest price that is traded and the high price (or 'high') is the highest price that is traded in a time interval.
One way to see all this information on a single chart is to use a bar chart. The diagram provided shows an individual bar with an 'open, high, low and close'. Each time interval is then assigned a bar.
The opening price is always shown by a 'tick' to the left of the vertical bar, while the closing price is shown by a 'tick' to the right of the vertical bar. The high and low price are represented by the highest and lowest point on the bar respectively.
The overall result then produces a chart similar to the following. This is called a bar chart.
By taking the idea of a bar chart a little further, a 'candlestick' chart can be created. Candlesticks still show the open, high, low and close for each time interval, however their construction is slightly different.
If the closing price for the time interval is higher than the opening price, an 'open box' is drawn between the opening and closing price. If the closing price is lower the opening price, a 'solid box' is drawn between the opening and closing price. A 'shadow' is then extended outwards from either end of the box to represent the high and low price (where appropriate).
Below are some further examples of candlesticks. Be sure to examine each one and make sure you understand why they look the way they do
The result produces a chart similar to the one shown. This is called a candlestick chart.
The charts types shown here are the most common types of charts used for technical analysis. They contain all the information required by the technical analyst. Certain patterns that appear in these charts can help to predict future price movement. Technical analysts also create tools called indicators to aid their trading but even these tools are mathematically derived from the price, time and/or volume.
Before giving examples of how bars and candles might be interpreted, we first must understand some basic market terminology.
When referring to the market, traders who believe that a share will rise in value are called 'bulls'. Their view on the future direction of the share is said to 'bullish'. Traders who believe a share will fall in value are called 'bears'. Their view on the future direction of the share is said to be 'bearish'. The same terminology will be used here.
Closing Price: The closing price is the most important price. This is because the market has had an entire time interval (e.g. a day) to make a decision on the share and decide whether or not to buy, sell or remain neutral. It is where the bulls and the bears, with all the information and emotion they both have, finally agree on a price for the share.
High Price: The high price for the time interval is the highest price at which the share traded. It is the price at which the bulls could no longer beat the bears. It is the price at which supply (of the shares) overcame demand.
Low price: The low price for the time interval is the lowest price at which the share traded. It is the price at which the bears could no longer beat the bulls. It is the price at which demand overcame supply.
The high and low are important because markets tend to have memory. For example, the bears may remember a price at which they won the battle against the bulls a few weeks ago and so if it gets to that high again, they will be sellers.
"I missed selling that share at $2.50 last week and now it's back at $2.25. If it gets to $2.50 again, I'll be a seller"
Open Price: The open price is the first price that trades for a particular time interval. It could be argued that the opening price is the least important price of the day. This is because the market has had since the previous closing period to decide what to do with the share. In this time, more information can be released and create uncertainty as to the value of the share. The opening period of any share is usually the most volatile (where many shares trade quickly and at different prices).
The following gives examples of bars (and their equivalent candlestick) and what can be interpreted from each of them.
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The bulls won the day as the stock finished (closed) higher than at the beginning of the day. Having said this, there was a point (at the high) that the bears overcame the bulls so it may be argued that the bulls have lost some of their commitment at the end of the day. |
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This is a similar bar to the one shown in the previous slide but in this example, the bulls have maintained their commitment from the first trade until the last trade. This is evidenced by the opening price also being the low price and the closing price also being the high price. |
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In this example, the bears have won the day as the stock has finished lower than where it opened. There is a point at the low where the bulls overcame the bears so it could be argued that the bears may have lost some of their commitment. |
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This bar is similar to the previous bar but the bears have maintained their commitment from the first trade to the last. This is evidenced by the opening price also being the high price and the closing price also being the low price of the day. |
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In this example, the bulls started the day with full commitment (the stock went straight up from the open). However, the bulls were overcome and the bears sent the stock back to the opening price. This particular bar is very bearish as it shows that the bears are now in control and that the buying 'frenzy' is over. This bar is often found at the top of a trend and signals a reversal of trend. |
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This example is the opposite to the previous bar. In this case, the bears began with full commitment. However, they were overcome by the bulls at the low who sent the stock back up to its opening price. Again, this particular bar is a very good indicator of a reversal in trend. It is often found at the bottom of a trend. |
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This bar does not show any trend whatsoever. If anything, it perhaps shows that there is uncertainty in the market as neither the bulls nor the bears can be declared the winner of the battle. |
(Note that in the last three examples, the bar and the candlestick were the same. This is simply because the open and the close were the same price and when there is no distance between the open and close, there will be no body).
A single bar gives only so much information. Technical Analysts wish to know if a price movement is part of an overall trend. In the picture below, we have several bars that appear to produce an uptrend.
Although a single bar gives information about price movement over a particular time period, technical analysts are interested to see whether this price movement may be part of a greater price movement or trend. To determine this, analysts must examine the relationship between consecutive bars. For example, a single bar may have the closing price less than the opening price for the day (suggesting that the bears won the battle on that trading day) but the closing price may be higher than the previous close for the fifth day in a row.
It can be seen that although the bears have won the final day, they have not won the week. The obvious question is, which is more important? Winning the day or winning the week? As a general rule, the longer a trend forms, the stronger that trend is. In other words, the answer to the question is that winning the week is more important. However, the technical analyst would certainly be interested in the last bar of the week because this could signal a change in the upward trend that was experienced over the week. A bar (or chart) formation that signals a change in the trend of the stock is called a reversal signal. The example above shows a 'closing price reversal'.
To summarise, technical analysts are more concerned with comparing consecutive bars and groups of bars rather than the individual bars alone. We form a consensus of whether the bulls or bears are in control by analysing the positions of the open, high, low and closing prices against each other.
A "trending" stock is a stock whose OVERALL movement is in one particular direction. Technical analysts would say that a stock is trending upwards if the stock is making 'higher highs and higher lows' or the stock is trending down if the stock is making 'lower highs and lower lows'.
Consider the chart of Hardman (HDR). High points have been marked at points A, B, C and D with low points being marked at E, F and G and H. It can be seen that HDR is trending up as B is higher than A, and C is in turn higher than B. D is in turn higher than C. This means that HDR is making higher highs. ALSO, point F is higher than point E and point G is higher than point F. This means that HDR is making higher lows. From these observations, it can be concluded that HDR is trending up.
Using similar analogies, the chart shows AMP (AMP) in a down trend. Points A, D and B are getting progressively lower, that is, the stock is making lower highs. Points E, C, F and G are also getting progressively lower. That is, the stock is making lower lows. It is therefore concluded that AMP is trending down.
The question will naturally arise, "What is the point of recognising that a stock is trending only after it has already made a considerable move? How is the beginning of a trend recognised?"
An up trend starts when a stock makes its second high after its second low.
Going back to the HDR example, the first low occurred on the 28th Jan, the low before A. The confirmation of the trend was on 2nd April at B, the point at which the stock makes its second high after its second low.
A down trend starts when a stock makes its second low after its second high
In the AMP example, the first high can be found at point A, the first low at point D and the second high at point B. The stock confirms the down trend on 7th Nov where a lower price than point D is first traded.
From this information, a very simple trading strategy can be constructed:
With the creation of trends, it was necessary for the stock to 'break past' an old price in order for the trend to be confirmed. Quite often, stocks tend to not break past this old price and 'bounce' back in the opposite direction from which it came.
This example shows a stock that could have potentially been forming a down trend. However, instead of the price passing the second low after the second high, the stock has 'bounced off' the price of the second low and continued upwards, past the price of the second high. The price that the stock bounced off is known as a support price. The stock is said to have found support.
The opposite can be said if the stock cannot break upwards through a price. The price that the stock cannot penetrate through is called the resistance price and the stock is said to have found resistance.
The above diagram shows an example of a stock that has found resistance. In this example, the stock hit the resistance price three times before it 'gave up' and retreated to lower prices.
The importance of support and resistance becomes apparent the more we study technical analysis. Lesson 4 (Chart Patterns) demonstrates the significance of this phenomena and explains some of the reasons why support and resistance exist.
In the previous examples, the red lines represented the lines of support and lines of resistance. As an extension of this concept, to help visualise the behavior and possible direction of the stock, technical analysts draw 'trend lines'. These are simply lines that show support and resistance in a trending stock. Returning to the HDR example, a supporting trend line could be drawn as shown
It can be seen that there is no 'fixed' support price. Rather, the price tends to follow a moving support line.
There is nothing to prevent a stock simultaneously having support and resistance lines.
The chart shows AMP trading between December and April. The stock is in a downtrend yet it can be seen that even in the down trend there is some support present. The resistance line is also drawn. Where two trend lines are drawn like this showing both the support and resistance of the stock running parallel, the trend lines are said to form a 'channel'.
Note also in the example that the chart has been displayed using a bar chart and not a line chart. The bar chart is able to give the technical analyst far more information that the line chart, i.e. information regarding the open, high and low price for each period as well as the closing price. When using bar charts, trend lines should be drawn between the extreme highs over the trend (in the case of lines of resistance) and between extreme lows (for lines of support). By following this convention, there should be no part (or a negligible amount) of the bars passing over the trend line. The bars should touch the trend lines in only a few places.
A final basic ingredient required for chart analysis is understanding volume. Many technical analysts prefer to ignore volume altogether believing that price movement is all important and any other information comes a very far second. However, others believe that volume demonstrates a conviction by the market supporting the price movement. In other words, the more volume that accompanies a price movement, the more people there are in the market who believe that price movement to be 'true'. A stock that moves up 10% on the back of one trade does not seem to be as significant as a stock that moves 10% with many millions of shares exchanging ownership.
Although this explanation is simplistic, it essentially summarises the most important part of volume: price movement should be accompanied by volume increase. Analysis of volume can become far more complicated than this, however, at this stage, keeping in mind, 'strong move, strong volume' should suffice for the analysis of volume. Also, keep in mind when analysing volume that the actual volume is not particularly relevant. Technical analysts are far more interested in how much volume is traded in a particular time period compared to how much was traded in previous time periods. In other words, the relative volume is more important than the actual volume.
This concludes the lesson on 'Introduction to Chart Analysis'. The lesson gave a broad overview of different characteristics that may be found in a stock chart and what they mean to the technical analyst. This chapter was by no means exhaustive. The field of technical analysis can be as complicated as the analyst wishes it to be. Over the years, comparisons between stock charts and number of sun spots, tidal levels and rainfall (for example) have been made and analysed. What has been presented here are some of the fundamentals of charting, something that most technical analysts agree on. As you will soon become aware as you venture further into the world of technical analysis, interpretation of the same chart can vary considerably. However, what is agreed by all technical analysts is the need to be consistent. If the number of sunspots for a particular day is a buy signal for you then use it. But keep to that system.
The remainder of these lessons contain methods of analysis that reach into the heart of technical analysis. They are tried and true methods, some dating back as far as 250 years. Marketech's advice to you when using technical analysis?... KEEP IT SIMPLE!