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June 24th, 2024

Essential Chart Types for Effective Market Analysis

To analyse trends and market sentiment effectively, it is important to understand which chart types suit your goals as there are many ways to view price data. Knowing which type of chart provides the most comprehensive information about price movement is crucial. Here, we will explore the main chart types: line, bar, and candlestick charts.

Line Chart

A line chart is considered the most basic of the three classical chart types because it only represents closing prices over a set period. A line is formed by connecting the closing prices of a particular asset according to the time frame. For many traders, the closing price is often considered the most important data point compared to the high and low prices for the day, hence it is the only value used to create line charts.

The downside of using line charts is that they do not provide visual information about the trading range for individual points, such as high, low, and opening prices. However, it is very easy to see how an instrument’s price has increased or decreased over time using only one data point. Line charts are helpful for analysing trends; if closing prices are getting higher over a period, this may indicate an upward trend, and if prices are getting lower, this may indicate a downward trend. Additionally, line charts offer a simple and effective way to spot support and resistance zones over any time frame, as it is easy to identify the ‘dips’ and ‘peaks’ over time.

Bar Chart

The bar chart, often referred to as OHLC (open, high, low, close), expands on the line chart by adding key pieces of information to each data point. It shows the high and low of the day, establishing the trading range of a particular instrument over a time period.

As a rule of thumb, if the left dash (open) is lower than the right dash (close), the bar will be shaded black, representing an increase in value. Conversely, a bar coloured red signals a decrease in value, with the dash on the right (close) lower than the dash on the left (open).

The downside to the bar chart, despite providing more trading information, is that it has poorer visibility compared to the line chart. The numerous bars on a screen can make it difficult to pick out exact price information.

Japanese Candlesticks

The first known investor to use Japanese candlestick charts was Munehisa Homma, a 15th-century Japanese trader who earned his fortune trading rice contracts in Osaka. Candlestick charts became widely known in Japan thanks to his methods and writings.

Candlestick charts are useful as standalone tools applicable to any market, but they can also be combined with other tools and techniques to create a powerful technical analysis system. Certain candlestick combinations may imply a period of consolidation, while others hint at a forceful price move, providing deep insights into market conditions.

Why Candlestick Charts?

Japanese candlestick charts differ from Western technical charts and analysis methods by considering human emotion, mass psychology, and sentiment. They emphasise the psychological aspects concerning opening, closing, and other market movements. Technical analysis assumes that current prices reflect all known market information. However, prices also represent factors like supply and demand, which are influenced by emotions and expectations, causing markets to move based on people’s expectations, not necessarily facts.

Anatomy of a Japanese Candlestick

Bearish Candlesticks: Usually red or black, these indicate negative sentiment for a particular time frame.

  • The upper horizontal line represents the opening price.
  • The lower horizontal line represents the closing price.
  • The shaded area between these prices is known as the body.

Bullish Candlesticks: Typically green or white, these indicate positive sentiment for a particular time frame.

  • The lower horizontal line represents the opening price.
  • The upper horizontal line represents the closing price.
  • The shaded area between these prices is known as the body.

The ‘shadow’ or ‘wick’ is the vertical line extending from the top or bottom of the body, showing the highest and lowest prices reached within a particular time frame, establishing the range of the candlestick. The shape of the body and the length and direction of the wick offer insights into the sentiment behind the candlestick.

Importance of Candlestick Placement

Candlestick charts provide an easy-to-follow, visual representation of price changes. They print green or white when the closing price of an instrument is higher than the opening price, and red or black when the closing price is lower than the opening price. For technical traders, understanding ‘reversal’ and ‘continuation’ candlesticks is crucial for identifying where buyers and sellers enter the market or react to historical price levels. These candlesticks have specific methods to assist with entering or exiting the market effectively.

This content is provided for general information purposes only and is not to be taken as investment advice nor as a recommendation for any security, investment strategy or investment account.

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