First Step of Technical Analysis

The First Step

Technical Analysis Step 1: Learn to read the charts
 
The first step to technical analysis is to learn how to read charts. There are many types of charts but they are generally similar. The most basic and commonly used one is the candlestick chart.
 
As shown below, each candlestick represents a specific time frame. If you have chosen a 30-minute time frame, then each candlestick will depict the trading activities within a 30-minute period. If you have chosen a day as the base time frame, then each candlestick will represent the transactions within the day.
 
As a technical analyst you need to study the following data:
 
· Price – Present & Historical
· Volume – Present & Historical
· Market Breadth – Present & Historical
 
If you don’t know where to start from then take help of an advisor or friend who practices this art. A lot of material is available online and a lot of good books are available too. It’s worth investing few bucks and hours in learning this art.
 
A black candle refers to a drop in price, meaning that the closing price is lower than the opening price. A white or unfilled candle refers to a rise in price, meaning that the closing price is higher than the opening price.
 
The horizontal lines at the top and bottom of the candlestick represent the opening or closing price, while the vertical lines that extend from above and below the real body are the highest and lowest traded prices within the set time frame respectively.
 
The candlestick patterns can be used to indicate when a market trend starts to reverse. If we can predict in advance when an upward trend will reverse, we can profit by going short in the market as early as possible. Similarly, if we can forecast that a downward trend is about to stabilize and rebound, we can grab this great opportunity to go long in the market. Candlestick patterns can also be used to determine whether the current trends will continue. Once you are able to master these patterns, you will be able to trade according to the trends. This will give you a lot of confidence to hold your positions or even add positions to earn bigger profits.
 
Technical Analysis Step 2: Learn to spot trends
 
Spotting the trend
 
The second step in technical analysis is to learn how to draw trend lines, as well as resistance and support positions. Using technical analysis it’s easy to find what’s the general trend of the market? It’s always beneficial to know if the market is in uptrend or downtrend.
 
Support position is the price position which is supported by buyers. When price falls and approaches the support position, it will tend to rebound. Resistance position is the price position where there will be tremendous selling pressure. When price rises and approaches the resistance position, it will tend to retrace. The support and resistance positions are usually determined using trend lines. Alternatively, you can also use other technical indicators such as Fibonacci lines, moving averages and Bollinger bands.
 
Drawing Trend Lines
 
In an upward trend, choose two ascending low points and join them to make an upward trend line. In a downward trend, choose two descending high points and join them to create a downward trend line. In order to improve the accuracy of the trend lines in predicting future market movements, we will filter away those trend lines that are not good enough, leaving behind those that will be useful for our analysis.
 
A trend line must undergo a series of tests before it can be considered useful and effective. Those that fail to meet these stringent criteria should be discarded.
 
First, the existence of a trend must be verified. An upward trend must have two consecutive ascending lows while a downward trend must have two consecutive descending highs. Only then a trend can be considered real and the straight line that joins the two points can be called a trend line.
 
Next, after the trend line is drawn, a third point must be identified to verify that the line is an effective one. In general, the more points a trend line touches, the more effective it is and the more accurate it will be in predicting future movement.
 
In addition, we must continue to adjust a trend line based on subsequent market situations. For example, when an exchange rate breaks below an upward trend line but then quickly rebounds to move above it, the analyst must redraw the trend line from the first low point to the new low point or try to produce a more effective line using the second low point and the new low point.
 
Finding support and resistance
 
Once you are sure of the trend of market, the next step is to find out the right entry and exit point with respect to specific stocks. Let’s say, you like a particular stock A and you want to buy it. Technical analysis suggests that you should not blindly invest in the stock. You should first try to find out what’s the best price at which you can get it. If you are ready to make your hands dirty, you can very easily find out the support price of the stock. In a volatile market, it’s very common for stocks to test their support prices. Just wait for few sessions and you will get a chance to enter the stock round its support price. Similarly, you can find the best price at which you should get out of a position which is the resistance of a stock. You can buy at support and sell at resistance to keep things simple. Ride this sine wave of support and resistance to reap great rewards.
 
Buy and hold policy will play for you if you are in up trending market. Keep on sniffing for the start of the downtrend as that’s the right time you book profit and be cash rich. Once the downtrend is over, you can again enter the market and ride it till the top. As the market is very volatile these days, you will get many chances of entry and exit. So, be patient and enjoy the capital appreciation.
 
Conclusion
 
Using technical analysis one can find answers to the following questions
 
1. When to enter the market.
2. Which stock to buy and at what price.
3. When to book profit .
4. Which stock to get out from so as to minimize loss.
 
Answers to above questions are a sure shot way of being successful in stock market. So, it’s better to roll our sleeves up and be ready to learn the art of Technical Analysis and mind you, it’s not as tough and confusing as it sounds.

Types of Stock Charts

Stock charts for investors are like the horses for the cowboy. The cowboy couldn't do without his horse,. The investor can't do without his/her chart. 

Stock charts are the foundation of technical analysis to the extent that technical analysts use charts almost exclusively. Stock charts provide a graphical representation that depicts price action and market data of the underlying security in a structured format. To the skilled chart reader, it provides an insight to the psychology of traders and balance of buying and selling pressure at that point in time and makes the recognition of trend lines and chart patterns possible.

Modern software have made charting a very simple practice and allowed technical analysts to quickly shift between time frames and to quickly apply a range of indicatorsto a price chart. However, there are different types of charts that can be used in technical analysis.

On this page you'll learn about the three most common types of price charts and how to read them.

We're going to look at four different stock charts. They are identical in that they all represent the price history for the same stock over the same time period. Notice how different they look.

There are four main types of charts that are used by investors and traders in order to determine the Trend of the Stocks.. The chart types are:  

1.the line chart,  

2.the bar chart,  

3.the candlestick chart and  

4.the point and figure chart.

In this section we have introduced how these charts are formed.

With the exception of point and figure charts, which only plots a price change when a new high or low is made, all charts plot price action for a specific duration of time, which is called the time-frame on a graph with the time on the horizontal axis and the price levels on the vertical axis. However, each type of chart plots price action differently, and displays different information about the price action in a given time-frame.

Bar charts and candlestick charts are widely used, followed by line charts. However,Point and Figure charts are not as widely used as they do not plot price action over a given time-frame. They also do not keep track of volume levels. For these reasons, oscillators and moving averages that are dependent on a fixed time-frame cannot be used on Point and Figure charts.

1. Line Charts

The Line Chart (above) shows a line interconnecting dots representing the closing price for each time period. In this case the time period is 13 days.

A line chart is the most basic and simplest type of stock charts that are used in technical analysis, because it represents only the closing prices over a set period of time. The line is formed by connecting the closing prices over the time frame. Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices. However, the closing price is often considered to be the most important price in stock data compared to the high and low for the day and this is why it is the only value used in line charts.

The line chart is also called a close-only chart as it plots the closing price of the underlying security, with a line connecting the dots formed by the close price. In a line chart the price data for the underlying security is plotted on a graph with the time plotted from left to right along the horizontal axis, or the x-axis and price levels plotted from the bottom up along the vertical axis, or the y-axis. The price data used in line charts is usually the close price of the underlying security.

The uncluttered simplicity of the line chart is its greatest strength as it provides a clean, easily recognizable, visual display of the price movement. This makes it an ideal tool for use in identifying the dominant support and resistance levels, trend lines, and certain chart patterns.

However, the line chart does not indicate the highs and lows and, hence, they do not indicate the price range for the session. Despite this, line charts were the charting technique favored by Charles Dow who was only interested in the level at which the price closed. This, Dow felt, is the most important price data of the session or trading period as it determined that period's unrealized profit or loss.

Line charts or close-only charts are still favored by numerous traders who agree the closing price is the most important data and are not concerned with the noise created price spikes and minor price movements, or the speculation that characterizes the start of the trading session.

2. Bar Charts ( OHLC and HLC )

The conventional bar chart (above) with the green and red full length vertical bars is seldom used, so we won't talk anymore about that one.

The OHLC Bar Chart.

The OHLC Chart (above) shows vertical lines, one for each day. The little line protruding from the left side of each bar is the opening price for that day. The little line protruding from the right side of each bar is the closing price for that day. The top of the bar represents the high price for that day. The bottom of the bar represents the low price for that day. In this case, you'll also notice that the vertical bars are either green or red dependent on whether it was an up day or a down day. This color feature is often not present with OHLC bar charts.

Bar charts are one of the most popular forms of stock charts and are probably the most widely used charts. Bar charts are drawn on a graph that plots time on the horizontal axis and price levels on the vertical axis.

The bar chart expands on the line chart by adding several more key pieces of information to each data point. The chart is made up of a series of vertical lines that represent each data point.

The chart consists of a series of vertical bars that indicate various price data for each time-frame on the chart. The close and open are represented on the vertical line by a horizontal dash. This data can be either the open price, the high price, the low price and the close price, making it an OHLC bar chart, or the high price, the low price and the close price, making it an HLC bar chart. 

The opening price on a bar chart is illustrated by the dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on the right.

Generally, if the left dash (open) is lower than the right dash (close) then the bar will be shaded black, representing an up period for the stock, which means it has gained value.

A bar that is colored red signals that the stock has gone down in value over that period. When this is the case, the dash on the right (close) is lower than the dash on the left (open). 

The height of each OHLC and HLC bar indicates the price range for that period with the high at the top of the bar and the low at the bottom of the bar.

The extra information is one of the reasons why the OHLC charts are more popular than HLC charts. In addition, some charting applications use colors to indicate bullish or bearishness of a bar in relation to the close of the previous bar. This makes the OHLC bar chart quite similar to the candlestick chart, except that the OHLC chart does not indicate bullishness or bearishness of the period of one bar as clearly as the candlestick chart (the color of an OHLC bar is always in relation to the close of the pervious bar rather than the open and close of the current bar).

Most bar charts contain a lower pane that plots the total volume traded during a particular period. This part of the chart has a separate scale on the vertical axis to illustrate volume levels. It too consists of typical vertical bars.

3. Candlestick Charts

The next chart we'll look at is the Candlestick Chart.

The Candlestick Chart provides more of a graphic image for that period of time, in this case one day per candlestick. Candlesticks with green bodies represent days in which the price moved up (i.e. the closing price was higher than the opening price).

The next chart is the same Candlestick Chart with labels identifying the various elements of the candlestick symbol.

On an day in which the price moved up, the top of the body is the closing price and the bottom of the body is the opening price. The top of the wick is the high price for the day. The bottom of the wick is the low price for the day. If there is no wick, then the closing price is the same as the high price for the day. If there is no tail, then the opening price is the same as the low price for the day.

Candles with red bodies represent days in which the price moved down (i.e. the closing price was lower than the opening price). On top of the candlestick is a wick.

Candlestick charts are probably the most widely used of the stock charts by experienced investors. Even though these charts might look a little strange to the beginner, they more readily communicate trading action for the experienced investor.

Note: Different stock charting services use different color coding schemes for up days and down days. They may also use different terms than wick and tail. Regardless, they all represent the same thing.

Candlesticks patterns are based on candlestick charts and are recurring chart patterns that consist of only a few candlestick, usually in the region of one to four candlesticks. Because candlesticks give an indication of strength and weakness of the current price movement, the candlestick patterns tend provide clearer indications of the probability of a possible trend reversals than any of the other chart types.

The candlestick chart is similar to a bar chart, but it differs in the way that it is visually constructed. Similar to the bar chart, the candlestick also has a thin vertical line showing the period’s trading range. The difference comes in the formation of a wide bar on the vertical line, which illustrates the difference between the open and close.

And, like bar charts, candlesticks also rely heavily on the use of colors to explain what has happened during the trading period. A major problem with the candlestick color configuration, however, is that different sites use different standards; therefore, it is important to understand the candlestick configuration used at the chart site you are working with. There are two color constructs for days up and one for days that the price falls. When the price of the stock is up and closes above the opening trade, the candlestick will usually be white or clear.

If the stock has traded down for the period, then the candlestick will usually be red or black, depending on the site. If the stock’s price has closed above the previous day’s close but below the day’s open, the candlestick will be black or filled with the color that is used to indicate an up day.

Candlestick patterns can be both bullish and bearish, depending on where they occur on the chart and where they occur within an existing trend. They can also be trend reversal or continuation patterns. The reliability of a candlestick pattern depends on the location of the pattern within the price chart, in terms of where it appears in an existing trend, and in relation to possible support and resistance lines, or other trend lines or pivot points.

The time-frame of the chart is also of importance as candlestick patterns on short time-frame, intraday charts tend to be less reliable than patterns on charts of a longer time-frame. Another possible consideration in determining the reliability of a candlestick pattern is the volume traded when the candlestick pattern is formed. If the pattern is formed on low volume, the pattern tends to be less reliable.

There are literally hundreds of candlestick patterns but not all of them appear with great regularity, and not all of them have a high degree of reliability and profitability. The more commonly occurring candlestick patterns include the a) engulfing pattern,

b) the harami,

c) hanging man and

d) hammer patterns,

e) doji or star patterns, and

f) the tweezers pattern.

We will focus more on the commonly occurring and high probability candlestick patterns than the more obscure patterns.

The Candlestick chart patterns, tends to increase the profitability of trading and is one of the key reasons why candlestick charts have become rather popular in recent years, especially among short-term traders.

4. Point and Figure Charts

Point and Figure (P&F) charts date back to at least 1880's and differ from other stock charts as it does not plot price movement from left to right within fixed time intervals.

The point and figure chart is not well known or used by the average investor but it has had a long history of use dating back to the first technical traders. This type of chart reflects price movements and is not as concerned about time and volume in the formulation of the points.

The point and figure chart removes the noise, or insignificant price movements, in the stock, which can distort traders’ views of the price trends. These types of charts also try to neutralize the skewing effect that time has on chart analysis.

When first looking at a point and figure chart, you will notice a series of Xs and Os. It represent increases in price by plotting X's in the column and  decreases in price by plotting O's. The Xs represent upward price trends and the Os represent downward price trends. Each X and O represents a box of a set size or price amount.

There are also numbers and letters in the chart; these represent months, and give investors an idea of the date. Each box on the chart represents the price scale, which adjusts depending on the price of the stock: the higher the stock’s price the more each box represents.

This box size determines how far the price must move before another X or O is added to the chart, depending on the direction of the price movement. Thus if the box size is set at 15, the price must move 15 points above the previous box before the next X or O is plotted. Any movement below 15 is ignored.

It also does not plot the volume traded. Instead it plots unidirectional price movements in one vertical column and moves to the next column when the price changes direction.

On most charts where the price is between $20 and $100, a box represents $1, or 1 point for the stock. The chart also has a box reversal amount that determines how many boxes must occur in the opposite direction before it is seen as a reversal.

Only once the price is seen as having reversed is a new column started. In a 3 box reversal requires the price to move three boxes (of 45 points if each box represents 15 points) against the current direction before it is seen as a reversal.

This is usually set at three but it can also be set according to the chartist’s discretion. The reversal criteria set how much the price has to move away from the high or low in the price trend to create a new trend or, in other words, how much the price has to move in order for a column of Xs to become a column of Os, or vice versa. When the price trend has moved from one trend to another, it shifts to the right, signaling a trend change.

For this reason, very little plotting occurs during stagnant market conditions while a considerable amount of plotting may occur during volatile market conditions.

Some traders argue that P & F charts are one of the best charting techniques for accurately determining entry and exit signals as they present a clear indication of support and resistance lines, as well as clear trend lines. P&F charts also trace its own set of price patterns, such as the fulcrum, the saucer, and the V base.

Conclusion

Charts are one of the most fundamental aspects of technical analysis. It is important that you clearly understand what is being shown on a chart and the information that it provides. Now that we have an idea of how charts are constructed, we can move on to the different types of chart patterns. Most of the traders are using Candlestick Patterns to predict the market movements but it’s all about depend on your comfortable level.

Types of Charts

CANDLESTICK CHART :

Although Candlestick charts were created in Japan are on record as being the oldest type of charts, dating back to the 1700's, when they were used for predicting rice prices, that are still used today in modern trading.

More significantly, candlesticks are fairly easy to read with a little practice and offer a wealth of information in a chart. Each plot point on a candlestick chart consists of a rectangular shaped body (think of it as the candle) with a vertical line (the wick) extending from both the top and bottom parts.

The candlestick chart is similar to a bar chart, but it differs in the way that it is visually constructed. Similar to the bar chart, the candlestick also has a thin vertical line showing the period's trading range. The difference comes in the formation of a wide bar on the vertical line, which illustrates the difference between the open and close.
And, like bar charts, candlesticks also rely heavily on the use of colors to explain what has happened during the trading period. A major problem with the candlestick color configuration, however, is that different sites use different standards; therefore, it is important to understand the candlestick configuration used at the chart site you are working with.

There are two color constructs for days up and one for days that the price falls. Candlesticks are colored and typically a dark candle indicates a downward movement while a light one shows that the stock moved upwards.

When the price of the stock is up and closes above the opening trade, the candlestick will usually be white or clear. If the stock has traded down for the period, then the candlestick will usually be red or black, depending on the site. If the stock's price has closed above the previous day's close but below the day's open, the candlestick will be black or filled with the color that is used to indicate an up day.

Each candlestick can be read to learn about the stock’s highest and lowest prices as well as its opening and closing prices.

The candlestick charts have become very popular among traders as they compress all important information such as the session's open, high, low, and close into a space-efficient symbol called candlestick.

In the West, often black or red candle bodies represent a close lower than the open, while white, green or blue candles represent a close higher than the open price.
 
LINE CHART :

Of all the available chart types, the Line chart is the simplest one. It is plotted by obtaining the opening and closing price of the stock for each segment of the time frame. The line is formed by connecting the closing prices over the time frame.

The closing price is especially important to many traders who use line charts since it helps to keep out the distractions of minor fluctuations that occurred during the time segment.

This is the simplest form of chart available to the technical analyst with time presented along the X-axis and price on the Y-axis. The actual time function that you plot will depend on your position in the market - a market maker will be interested in price fluctuations on a minute-by-minute basis, whilst the average investor will only be interested in a price on a daily or even weekly basis. Any price may be plotted on a line chart, but the most common is the closing, mid-price.

The largest benefit to the analyst of drawing line charts are their simplicity. They present an uncluttered picture of price movements and are very easy to understand.

Line charts are also used when there is not enough data provided for a certain stock. This lack of data can also make it difficult for traders to predict the stock’s future movements.

Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices.

However, the closing price is often considered to be the most important price in stock data compared to the high and low for the day and this is why it is the only value used in line charts.

OHLC CHART :

The Open-high-low-close chart (OHLC charts, also known as bar charts) expands on the line chart by adding several more key pieces of information to each data point. Unlike line charts, bar charts plot price data by using a series of vertical bars with a horizontal line intersecting each one on the graph. Each vertical bar corresponds to the price changes during the chosen time period.

The chart is made up of a series of vertical bars that represent each data point. This vertical bar represents the high and low for the trading period, along with the closing price.

The close and open are represented on the vertical bar by a horizontal dash. The opening price on a bar chart is illustrated by the dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on the right.

Generally, if the left dash (open) is lower than the right dash (close) then the bar will be shaded black, representing an up period for the stock, which means it has gained value.

A bar that is colored red signals that the stock has gone down in value over that period. When this is the case, the dash on the right (close) is lower than the dash on the left (open).

This style of displaying data offers a little more information to traders than line charts, which can be far more helpful when predicting future trends.

Many analysts look for patterns in bar charts to make an educated guess as to how the market is going to move.

A bar chart shows at least three pieces of information: the high, the low and the closing price for each time interval. Some bar charts also contain a fourth piece of price information, the opening price. Each time interval (that is, day, week, or five-minutes) is represented by one bar.

Each bar represents one day's price action. Just as with the line chart, price data is placed on the vertical axis, and time is measured on the horizontal axis. A vertical line shows the trading range for that day. A longer line denotes a wider trading range during the day. Likewise, a short bar means that the spread between the highest price during the day and the lowest price during the day was small. A small tick mark on the right side of the bar indicates the closing price for the day. If the opening price for the day is recorded on the bar chart, it is represented by a small tick mark to the left side of the bar.

POINT AND FIGURE CHART :
 
Point and figure charts are one of the great secrets of the Technical Analysis world. Highly sophisticated and with a thoroughbred pedigree, they can, however, be overlooked by traders today.

The point and figure chart is not well known or used by the average investor but it has had a long history of use dating back to the first technical traders. This type of chart reflects price movements and is not as concerned about time and volume in the formulation of the points.

Charting the price action by Point & Figure charts (P&F charts) is a very effective method to know the true picture of the market trend by avoiding the market noises or insignificant moves in the stock, which can distort traders' views of the price trends. These types of charts also try to neutralize the skewing effect that time has on chart analysis.
 
When first looking at a point and figure chart, you will notice a series of Xs and Os. The Xs represent upward price trends and the Os represent downward price trends. There are also numbers and letters in the chart; these represent months, and give investors an idea of the date. Each box on the chart represents the price scale, which adjusts depending on the price of the stock: the higher the stock's price the more each box represents.

On most charts where the price is between $20 and $100, a box represents $1, or 1 point for the stock. The other critical point of a point and figure chart is the reversal criteria. This is usually set at three but it can also be set according to the chartist's discretion. The reversal criteria set how much the price has to move away from the high or low in the price trend to create a new trend or, in other words, how much the price has to move in order for a column of Xs to become a column of Os, or vice versa. When the price trend has moved from one trend to another, it shifts to the right, signaling a trend change.

In today’s world the information availability is very easy. Be it the fundamental factors which affect the financial market or the actual ongoing price data at every moment. Getting hold of the information is not an issue, what is important is how do we organize the various bits and pieces and process those to analyze the same in a meaningful way.

In speculative trading markets the prices change every moment but every move of the price is not important. here is a lot of movement and insignificant spike in the price-action which can be ignored simply ignored as meaningless. Point & Figure charting helps us in doing that in a very effective way.

KAGI CHART :

Kagi charts are price charts with thick and thin vertical lines connected by short horizontal lines. Just like P&F charts, Kagi charts only add a new vertical line when prices have reversed enough to cancel the current uptrend or downtrend. Until such a reversal occurs, a Kagi chart will only move up (or down) in its current column. Kagi charts do not have constantly spaced time axes. Here is an example of a Kagi chart:

The word "Kagi" comes from the Japanese art of woodblock printing. A kagi or "key" is the L-shaped guide in a woodblock that a printer used to line up the paper for printing. Because of this, Kagi charts are sometimes referred to as "Key charts." Kagi charts were popularized by Steve Nison in his book Beyond Candlesticks.

The thickness of the Kagi line changes depending on price action. The thick line is called the yang line and the thin line is called the yin line. The locations where the line changed from moving higher to moving lower are called "shoulders" and the locations where the line changed from moving lower to moving higher are called "waists". Whenever a yin (thin) line moves above the previous shoulder, it turns into a yang (thick) line. Similarly, whenever a yang line moves below the previous waist, it turns into a yin line.

The Kagi line will continue to move up (or down) until prices reverse by a specified amount. When that happens, a short horizontal line is added as well as a new vertical line which extends to the new closing price. There are several ways to specify the reversal amount - in absolute points, as a percentage, or by using the Average True Range of recent prices.