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Basics of Technical Analysis
In this lesson we will go over the various types of charts that are available to traders to conduct technical analysis of a currency pair.
Types of Charts
Technical Analysis all comes down to the reading and interpretation of charts in the quest to identify a high probability entry into a trade.
The three most widely used types of charts are the Line chart, the Bar chart, and the Candlestick chart. Below you will find examples of each.
Of the three, the Line Chart is the most basic. It is created by connecting a series of data points (such as the closing price of the currency pair) together with a line. As can be seen on the example above, the line simply follows the price action so the trader can make a determination as to the direction of the trend based on the past data points shown. More often than not, a line chart is used on longer time frames to make a simple and quick judgment about how the pair has been moving over the designated time frame.
A Bar Chart provides additional information that can be valuable to a trader. Let’s take an expanded view of the Bar Chart and focus on just one bar to see what it tells us.
The chart at which we are looking is a Daily chart -- that means that each bar represents how the price for the pair traded over 24 hours of time. Specifically, the bar will show us the price at which this pair opened trading, the high and the low price that it reached during the time frame, and the last price the pair traded at that day. These details are noted on the chart below.
(A new Daily bar will open at 5 PM Eastern US Time as the previous Daily bar closes at the same moment.)
The additional details provided here can greatly assist the trader. For example, the trader can tell that during this time frame the pair continued its bullish upward move, since the closing price was above the opening price.
Lastly, we will take a look at the most widely used type of chart for forex trading, the Candlestick chart.
Below you will find a visual of the basics of candlestick interpretation.
At first glance of this Daily Candlestick Chart one can see the benefits of using this type of chart over the line chart and the bar chart straightaway. Based on the colors of the candles -- blue for a bullish candle that closes higher than it opened, and red for a bearish candle that closes lower than it opened -- it is readily apparent which days were days of upward momentum and which days had downward momentum.
Let’s take closer look at the above chart.
As you may have seen the information provided by the candlestick chart (high, low, opening and closing prices) is the same information provided by the Bar Chart. However, the information is much more readily discernible when put in this format, because of the colors of the candles.
When looking at any candlestick, a bullish candle or a bearish candle, the top of the wick and the bottom of the wick represent the highest and lowest price to which the pair traded during that time frame. The main difference between a bullish candle and a bearish candle, other than the color, is where the opening and closing designations appear.
Since the blue bullish candle closes higher than it opens, the top of the candle’s body is where price closed and the bottom of the body is where the price opened. In the case of a red bearish candle, the top of the body will be where pair opened during that time frame and the bottom of the body will be where the pair closed…the reverse of the bullish candle.
In using candlestick charts, keep in mind that as you move among the various time frames, each candlestick will represent that time frame. So, if you are looking at a Daily chart, each candle represents one day (24 hours). If you are consulting a 4 hour chart, each candle will represent 4 hours of time and so forth. Of the three chart types presented here, the candlestick chart provides the all the necessary information in a way that is most readily interpreted visually as well.
You should now have an understanding of the three primary types of charts and how they can be used in trading.