Charts are an intrinsic part of stock trading because each chart tells a different story. Stock market data can run into thousands and thousands of rows and columns. If viewed just as numbers, they might make no sense to the naked eye, but by converting them to different types of charts, investors can easily glean the right information to make well-informed decisions.
While there are many tools, software, and algo trading platforms to help convert raw data into fancy charts, as a beginner, it is important to understand the basics of the different types of charts used in trading stocks.
In simple terms, a chart plots historical data based on a combination of share price, volumes traded, and/or time intervals to give you a visual representation of the data. Different types of charts allow for different types of inferences. Let us look at the five types of charts that any investor should know about before they start trading.
Line charts are the most basic types of charts used by traders and are considered to be a stepping stone for new traders. They are used to plot the closing price of the underlying security (stock, index, commodity, currency) with a particular time frame. The time frame could be in the range of minutes, days, weeks, months, or years. Line charts are favored by traders because they provide an uncluttered view of closing prices without reflecting any of the noise or spikes in price changes. The closing price is still considered to be one of the most important factors by many traders.
Bar charts are also a popular type of chart for traders. Bar charts are designed on a graph that plots time on the horizontal axis and price levels on the vertical axis. The price level is depicted by a vertical line, which corresponds to the high and low prices for a particular period, with a tick for the open price and close price. If the data includes open, high, low, and closing prices, it is referred to as an OHLC Bar Chart.
If it only includes the high, low, and close prices, it is called HLC Bar Chart. These charts are much more informative as compared to the line charts because they allow traders to analyze trends or movements, spot potential trend reversals, and monitor any volatility or price movements.
A deviation from the bar chart, a candlestick chart gives prominence to the open and close prices of a security as compared to the high and low prices. The open and close price points are plotted as the two ends of a rectangular box (called real body), while the high and low prices are plotted as a line(called shadow), giving the impression of a candlestick. If the opening price is lower than the closing price (stock is appreciating), the box is colored green or white. On the other hand, if the closing price is lower than the opening price, the box is colored red or black.
The candlestick chart shows investors how a stock could move from being bearish to bullish or the other way around. It also shows the support or resistance level of a stock, cautioning the trader of a trend reversal.
Point & Figure Chart
A Point and Figure (P&F) chart showcases price movements and trends in any security without the duration of time. A P&F chart differs from other stock charts in a way that it does not plot data over time. Instead, it plots unidirectional price movement in a vertical column and moves to the next column only when the price movement reverses. These charts depict columns consisting of stacked X’s and O’s, each of which symbolizes a fixed unit price movement. X denotes an increase in the unit, while an O depicts a fall.
Determining the unit price movement is key, and can be changed to create a figure, which will filter out minor price spikes or noise typically created in any stock market. Thus, a P&F chart can show clearly defined support and resistance levels for a particular price point without taking into consideration any flutter.
It is a well-known fact that the law of demand and supply causes the change in the price of a security. The P&F chart shows when is the best time to buy or sell the stock. Since their introduction, P&F charts have been deeply integrated into other technical analysis and trading strategies and are used primarily by long-term traders.
The term Renko is derived from a Japanese word meaning ‘bricks’ and is based on candlestick charts. Instead of using X and O, the Renko chart uses equal shaped bricks, which are plotted diagonally based on the price movement. A new brick will appear only if the price has moved (up or down) by the pre-determined unit price. The new brick is always formed at the top or bottom corner of the preceding brick, never at its side. The visual simplicity of the Renko chart makes it ideal to use for day traders to identify the emergence of a new trend.
While it is essential to know how to read these basic stock charts, for every investor, it is equally important to learn to correlate other factors. These factors could include trading volume, price movement after trading hours, identifying lines of support and resistance, earning per share (EPS), market capitalization, and many others. The more informed you are, the better will be your trading decisions.
Different charts are used for identifying trends and the potential direction of the security or market. Once you familiarize yourself with the various trading charts, the next step would be to understand and identify the different patterns that emerge from the charts.