Technical analysis can be defined as the concept of finding short-term trading opportunity in the market. These opportunities are based on the analysis done on the statistical data generated by the actions of market participants. These actions can be visualized and studied by means of charts. These charts form overtime pattern like weekly, daily, monthly etc and convey different message[G1] s which help in making a trade. [G2]
We only need open, close, low and high price points for the day to summarize the day trade and not all the price actions.
Open Price: It is the price point at which the first trade in the day took place.
Close Price: It is the price point at which the last trade in the day took place.
High Price: It is the highest price point at which the trade took place during the day.
Low Price: It is the lowest price point at which the trade took place during the day.
So, by tracking these price points we can try to analyse the day’s action for the stock.
Since we have recognized that we only need open (O), high (H), low (L), and close (C) to summarize the market participant actions for the given time frame, now we need a good charting technique which can display this data in the most effective way. If the charting technique is not good then it will become extremely confusing and complex to interpret the data for example if we are looking at a weekly chart, we need to visualize 28 data points (7 days x 4 data points per day). So, we can imagine how confusing it would be to interpret 6 months or a year’s data.
The regular charts pattern like the column chart, pie chart, area chart etc won’t work with plotting these data as they mainly work with only one data point at a time and we need to plot four data points in a single chart.
Charts which works with Technical Analysis
Japanese Candlestick chart
It is the most basic chart type and only exemption of the concept of plotting four data points in a single graph. A line chart can be plotted by using a single data point and in this, it uses the closing price to plot the chart.[G3] [G4] [G5] [G6] [G7]
This is the one-year line chart of Idfc bank.
The biggest advantage of a line chart is its simplicity. A trader can identify the trend of the stock just by one glance at the chart.
They can be plotted for any time frame namely monthly, weekly, daily etc.
The advantage of the line chart is also the disadvantage as its simplicity can only showcase the trend and nothing else or any other additional detail.
It is a bit more versatile and useful as it contains all four price points.[G8]
Bar chart contains three components
A central line: The top of the line indicates the high price for the day and the bottom of the line indicates the low price.
Left Mark/Tick: Indicates the open price of the day
Right Mark/Tick: Indicates the close price of the day
Source: Yahoo finance
This is a one-month bar chart of Eicher Motors
The left and right mark position of the bar varies based on the way the market has moved in the given day. Suppose if the left mark is below the right mark it shows that closing price is above the opening price which indicates a positive day.[G9]
If the right mark is below the left mark it shows that the opening price is above the closing price which indicates a negative day for the stock.[G10]
The length of the line indicates the range for the day. As bigger the line indicates higher the volatility and vice-versa.
It is more insightful then line chart and contains all four required price action which properly sum-up the day.[G11]
It lacks visual appeal. It is very hard to track potential sign or pattern by looking at the bar chart. The complexity also increases when the trader tries to look at multiple charts.[G12] [G13] [G14]
This chart type was originated in Japan where it was used by a rice merchant named Homma Munehisa. Now it is the most used chart technique by the traders.[G15]
There are two types of candlestick
Bullish Candle generally denoted with green colour
Central Body: It indicates the difference between open price and close price. In a bullish candlestick, the closing price is more than the opening price [G16] [G17]
Upper shadow: It is the difference between the closing price and day’s high.
Lower Shadow: It is the difference between the opening price and day’s low.
Bearish Candle generally denoted with red colour
Central Body: It indicates the difference between open price and close price. In bearish candlestick, the closing price is less than the opening price[G18]
Upper shadow: It is the difference between the opening price and day’s high.
Lower Shadow: It is the difference between the closing price and day’s low.
Source: Yahoo finance
This is Japanese Candlestick one-month chart of Pc jewellers
It is easier to interpret the day by looking at the candlestick pattern rather than a bar chart. It helps you to quickly interpret the relation of four price points and make [G19] [G20] strategy accordingly.
Inserted: A l