Technical Analysis

Technical analysis uses indicators based on price and volume to make investment decisions, often based on probabilities and risk-reward trade-offs. Technical analysis assesses supply and demand, trends, sentiment, momentum, patterns, seasonality, market cycles, money flows, and other analysis techniques for security selection decisions and directional biases.

Price charting

Price charts display a series of prices over a defined time period. Price charts come in many forms. Line, bar, and candlestick charts are the most commonly used. 

Price is typically plotted on the y-axis, and time is plotted on the x-axis of the chart. Less common price charts may vary the typical axes and have non-standard time spacing. 

For example, renko charts have non-standard time spacing and equivolume charts incorporate volume into the width of the candles. 

Price charts can show prices for any specified period of time, including intraday, daily, weekly, monthly, or annually. The type of chart used depends on the desired use for the price data and trading strategy. 

For example, long-term economic trend data is typically depicted with a line chart using a monthly or yearly time frame.

Bar charts are perhaps the most commonly used chart type, while candlestick charts can have unique trading patterns based on the candle’s size and coloring.

Each chart type has an intended use and represents price data in unique, meaningful ways. Some chart types are suitable for seeing each day’s price range while others simply show the closing price.

Line charts

Line charts plot the closing price of a security and connect each point with a line. Line charts are a visual representation of a security’s price. Line charts are the most basic chart type and are simple to create as only two data inputs are needed: the date and corresponding closing price value.

While daily line charts are the most common, each data point on a line chart may be the closing price for an hour, a day, a week, a month, and so on.

Because the closing price is a primary input for many technical indicators and signals for trading strategies, other data, such as the day’s high, low, or open found in other chart types, may be unnecessary. Therefore, many investors start with line charts.

OHLC bar charts

OHLC bar charts illustrate the entire range for a period by indicating the opening, high, low, and closing prices on one bar.

The opening price for the period is a horizontal line pointing to the left. The closing price for the period is a horizontal line pointing to the right. The high price for the period is the top of the bar while the low price for the period is the bottom of the bar.

In contrast to line charts, where each data point is connected, OHLC bar charts show price gaps in a chart. Gaps from one bar to the next show where no trading activity occurred between the two period’s respective highs and lows.

Bar charts display the day’s full price range and provide additional context to price movements compared to line charts. The longer the bar, the larger the period’s price change. 

Bars provide trading setups similar to candlestick charts with patterns and combinations of bars, such as reversals, inside bars, outside bars, triangles, etc.

Candlestick charts

Candlestick charts illustrate the entire range for a period by indicating the opening, closing, high, and low prices of a period in a single price bar.

The space between the opening and closing prices of the period forms the candlestick’s body. Prices above and below the opening and closing range form the candle’s wick, or shadow.

The size of the candlestick body relative to the candlestick wick is informative of the strength or weakness of price direction for the period. For example, long upper shadows may show a significant intraday reversal lower while a longer lower shadow may show strong momentum into the close.

Candlestick charts are similar to OHLC charts, but the candle’s “body” provides added information. Candles are color-coded to express if the day’s close was higher or lower than the open.

In full-color charts, the candle’s body is green if the closing price is above the opening price. If the closing price is below the opening price, the candle’s body is red. If the opening price is above the closing price, but the period’s price closes above the previous period’s close, the candle’s body is black.

Candlestick charts may provide trading signals through patterns based on one, two, three, or more candles. Candlestick patterns are known for their intriguing names, such as three black crows, doji, and shooting star.

Logarithmic vs. linear price scaling

The scaling of price charts may be varied to allow longer time periods or wider price ranges to be viewed on different scales. Charts may have logarithmic (log or semi-log) or arithmetic (linear) price scaling.

The space between each point on the chart’s vertical axis is identical on an arithmetic scale. The space between each point on the chart’s vertical axis corresponds to the percentage change between the points on a logarithmic scale.

If an investor wants to measure a move in terms of price, linear scales are often used. If an investor wants to measure a move on percentage terms or if the price change has been significant over the period of time displayed, logarithmic scales are typically used.