Introduction to using Charts in Trading

Using charts in trading offers traders a visual interface into the marketplace. Traders make use of charts in order to understand the market dynamics that are in play behind the price action. No matter what you trade, stocks, options, forex or commodities, trading without using charts is like driving blind.

Charts are relatively easy to grasp, perhaps because they are visual. However it can be misleading as most beginners in trading tend to use charts without having any basic knowledge to help them in their chart analysis. Charts do not predict the future price of the instrument, but when analyzed correctly can tell the trader a great deal on how to trade, when and what.

There are many types of charts but the most commonly used chart types are

Different Types of Charts
Different Types of Charts

At the outset, analyzing charts correctly would reveal the following information to the trader. Here are some of the basics that charts can tell you.

  • When to buy or sell and the reasonable price based on your trading style and tolerance to risk
  • Charts give a glimpse of the upcoming trendline patterns, this informing the trader what kind of strategies would be ideal
  • Important factors such as where to place the Stop Loss or Take Profit based on the support and resistance lines that are formed
  • The chart’s angle of ascent or descent gives a great insight into the price action’s sustainability and the likelihood of the trend to move in the same direction

Components of a Chart

Price, Time and Quantity are three important data that is depicted on the chart and of these three, price is considered to be significantly the most important. However, when analyzing charts, all three components should be considered.

Price, in a chart is depicted in different ways, of which the most popular happens to be candlestick charts (besides line and bar chart). Price is indicated by other elements such as the open, high/low and the close during a period of time. The difference in price, be it high or low is calculated based on the previous’s day or time frame’s closing price.

Time forms an essential element as it shows the trader’s perspective in order to determining the change in price for an instrument. The element of time closely follows price in terms of importance. By making use of price and time in charts, traders can determine the impact of time on price at different intervals such as 5 minutes, intra-day, week, month.

There are other types of charts such as Point and Figure for example which completely eliminates time and only focuses on price.

Quantity, in charts is represented by what is known as ‘Volume’ which is nothing but the total number of trades for a given period of time, Volume or Quantity offers a visual representation in the chart as a histogram and changes on the period. For example you might see 1 million volume on a daily chart, while a 5 minute chart could show a volume of 100k during a 5-minute time frame. Quantity can be used to study the number of trades and can be used in relation to price fluctuations. This data can prove to be helpful for traders in determining any discrepancies, price correction, fading volumes and so on and can act as an indicator for any upcoming price changes even before they begin.

Despite Volume being used in forex charts, there is a general debate on the accuracy of the volume. Due to the OTC nature of forex, it is hard to ascertain the real volume, unlike stocks which are traded through an exchange and thus shows a clear representation of volume or shares traded during a time period.

Within the realm of quantity, there is another aspect called share lot size which offers an even deeper insights into the analysis of an instrument. Using the lot size, traders would be able to identify which lots are being bought and sold.

When all three elements of a chart, Price, Time and Volume are put together, the patterns on the charts are formed that can expose trend direction as well as its strength and momentum.

Charts are graphical representation of the price in the markets for an instrument and forms one of the basic criteria when trading the markets. The information that one can derive from the charts can help the investors to have an idea of not just the present market conditions and also gives a glimpse into the trader/investor emotions and sentiment (greed, fear). It is always advisable that when starting off with using charts, always start with the basic layout slowly advancing to other concepts. By having a firm understanding of the price action in the charts, traders would be able to better understand the basic underlying emotions that drive the prices.

Which chart type is better?

There is no question as to which chart type is better. Rather the question that needs to be asked is which chart type should be used in certain conditions. For example in low liquidity markets, a line chart is more appropriate than Candlestick or Bar charts, likewise, in a highly liquid market Candlestick charts tend to show market sentiment much better than line charts. For those who want to eliminate the noise, using a time-independent chart type such as Renko or PnF is more appropriate.