Understanding Technical Analysis, Reading Stock Charts

In its purest form, technical analysis is the study of charts with the goal of determining future price actions. While this method may appear straightforward, the obvious question is what types of charts are available? For studying the markets through reading stock charts, these four main chart types are used:

1. Daily bar chart– This is the most widely used chart. It is constructed to show four pieces of information: opening price, closing price, high of the day, and low of the day. Looking at each day’s history, a vertical line shows the day’s range with a horizontal line pointing left to mark the opening price and a horizontal line pointing right to mark the closing price.

gs-daily-bar-graph

2. Candlestick chart – This chart presents the same data as a bar chart, but in a slightly different format. The chart has two main parts. The first is the thin line, known as the “shadow,” which shows the price range from high to low. The wider area, known as the “real body,” measures the difference between the opening price and the closing price. If the close is higher than the open, the real body is white.

gs-candlestick

3. Line chart – A line chart measures only the closing price and connects each day’s close into a line. Many technicians believe closing price is the only point that matters. For them, a line chart may be the most appropriate study.

gs-line

4. Point and figureA point and figure chart is concerned only with price, not time or volume. The chart uses an X to mark increases in price and an O to mark lower prices. With this approach it is easier to spot trends and reversals. However, since time is not used as an input, P&Fs offer little guidance on how long it will take for profit objectives to be met.

gs-point-and-figure

Each chart type for performing technical analysis has its benefits. Personally, I believe closing price trumps all else, but intraday action matters as well. To obtain the data I need, I use daily bar charts for trend analysis and point and figure for long-term profit objectives. By exploring the options each approach provides, investors can determine which type best meets their needs for reading stock charts.

Sean Hannon, CFA, CFP is a professional fund manager.

Further Education, Technical Analysis:

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