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Technical Analysis Challenge: Introduction to Chart Types
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bullrider_21 joined discussion · Jul 28, 2023 15:41

Which chart type is better?

Understanding candlesticks
Candlesticks are used to show the price action of a stock. They are the foundation of technical analysis (TA). Technical indicators are applied to them in TA. A chart is made of bars that have little lines stemming from the top and the bottom; these are known as candles. The candle conveys 4 pieces of information: open price, close price, high price and low price.
Candles refer to that information for a specific period of time. For a daily chart; each candle represents one day. And thus, each candle constitutes, the open, close, high, and low price for that given day. The figure below shows the bullish and bearish candles.
Fig. 1. Bullish and bearish candles.
Fig. 1. Bullish and bearish candles.
The wicks, or shadows, are the thin lines are outside the rectangular body of the candle. They represent the high and the low price during that time period. The colour of the candle is also significant in understanding whether the open price was higher or lower than the close price. If the candle is hollow or denoted as bullish, this means that the open price is lower than the close; and the opposite is true if the candle is filled, or denoted as bearish.
Hollow candlesticks indicate buying pressure. Filled candlesticks indicate selling pressure. The hollow and filled can be replaced with green and red colours respectively.
Long and short bodies
Long white candlesticks show strong buying pressure. The longer the white candlestick is, the further the close is above the open. This indicates that prices advanced significantly from open to close and buyers were aggressive. While long white candlesticks are generally bullish, much depends on their position within the broader technical picture. After extended declines, long white candlesticks can mark a potential turning point or support level. If buying gets too aggressive after a long advance, it can lead to excessive bullishness.
Long black candlesticks show strong selling pressure. The longer the black candlestick is, the further the close is below the open. This indicates that prices declined significantly from the open and sellers were aggressive. After a long advance, a long black candlestick can foreshadow a turning point or mark a future resistance level. After a long decline, a long black candlestick can indicate panic or capitulation.
Long and short shadows
Upper shadows represent the session high and lower shadows the session low. Candlesticks with short shadows indicate that most of the trading action was confined near the open and close. Candlesticks with long shadows show that prices extended well past the open and close.
Candlesticks with a long upper shadow and short lower shadow indicate that buyers dominated during the session, bidding prices higher, but sellers ultimately forced prices down from their highs. This contrast of strong high and weak close resulted in a long upper shadow. Conversely, candlesticks with long lower shadows and short upper shadows indicate that sellers dominated during the session and drove prices lower. However, buyers later resurfaced to bid prices higher by the end of the session; the strong close created a long lower shadow.
Long white candlesticks indicate that the bulls (buyers) controlled the trading for most of the session.
Long black candlesticks indicate that the bears (sellers) controlled the trading for most of the session.
Small candlesticks indicate that neither group had the upper hand and prices finished about where they started.
A long lower shadow indicates that the bears controlled the trading for part of the session, but lost control by the end and the bulls made an impressive comeback.
A long upper shadow indicates that the bulls controlled the trading for part of the session, but lost control by the end and the bears made an impressive comeback.
A long upper and lower shadow indicates that the both the bears and the bulls had their moments during the session, but neither had the upper hand, resulting in a standoff.
Candlestick chart
A candlestick chart shows the candlesticks of a stock over a period of time. It shows all the above-mentioned information associated with candlesticks.
Fig. 2. Candlestick chart for MSFT.
Fig. 2. Candlestick chart for MSFT.
Line chart
Line charts are created by plotting a line between the closing prices for each period on the chart. A line chart is simple chart for showing the closing prices and trend of a stock. It doesn't provide information about the open, high and low prices for a period. So it is not very useful for TA.
Fig. 3. Line chart for MSFT.
Fig. 3. Line chart for MSFT.
Bar (OHLC) chart
Besides open and close prices, an Open-High-Low-Close (OHLC) bar chart also provide volatility information. An OHLC bar is shown below. The chartist Volatility can be evaluated by the height of the bars and the conviction of the buyers and sellers by the price range between the open and close prices.
Fig. 4. OHLC bar.
Fig. 4. OHLC bar.
A OHLC bar consists of a vertical line and 2 horizontal marks. The height of the vertical line represents the high and low prices. The open price is marked to the left of the line and close price is marked to the right.
For the left bar, the close price is above the open price indicating price ended higher for the day, known as an up day. This price bar is considered bullish. Bullish sentiment is present when greed for gain exceeds fear of loss and prices move higher. If the close price is higher than the previous day's close price, the price bar will be green.
For the right bar, the open price is higher than the close price indicating price ended lower for the day, known as a down day. This is a bearish price bar. Bearish sentiment is present when fear of loss is greater than greed for gain and prices move lower. If the close price is lower than the previous day's close price, the price bar will be red. The OHLC bar chart is shown below.
Fig. 5. Bar chart for MSFT.
Fig. 5. Bar chart for MSFT.
Heikin-Ashi chart
Heikin-Ashi means an "average bar" in Japanese. The Heikin-Ashi chart is a type of advanced candlestick chart. Since Heikin-Ashi takes an average of the price movements, this chart type shows trends and trend reversals more clearly than standard candlestick charts.
While Heikin-Ashi is a chart type, it is also a technical indicator as it takes actual price levels of the underlying asset and then converts those prices based on the Heikin-Ashi formula.
Heikin-Ashi indicator signals
The Heikin-Ashi technique reflects the trend prevailing in the market through indicator signals. There are two main aspects of the Heikin-Ashi indicator signals: trend strength and trend reversal.
Fig. 6. Heikin- Ashi chart for MSFT.
Fig. 6. Heikin- Ashi chart for MSFT.
1) Trend Strength
Bullish trend: Many consecutive green candlesticks without lower shadows show a strong signal for an uptrend.
Bearish trend: Many consecutive red candlesticks without upper shadows show a strong downtrend signal.
Chart patterns: Traders can use continuation chart patterns, such as wedges, flags, and triangles, with Heikin-Ashi indicator the same way they do with the regular candlestick chart.
2) Trend Reversal
A trend reversal signal helps determine the time to exit a previous trend-following trade and enter a new trend. A trader can avoid losses and profit by entering a new trade instead by identifying a reversal signal.
Doji candlestick: A candlestick with a small body and long shadows. For a regular candlestick chart, it signals indecision. When it comes to the Heikin-Ashi, it signals a trend reversal.
Fig. 7. Heikin- Ashi doji candle.
Fig. 7. Heikin- Ashi doji candle.
Chart patterns: Traders can use reversal chart patterns, such as wedges, flags, and head and shoulders, with Heikin-Ashi indicator the same way they do with the regular candlestick chart.
Pros
It is easy to interpret as any trader can read the candlestick patterns. Heikin-Ashi candlesticks are better deciphered than traditional candlestick charts. Hence it's easier to identify market trends and patterns.
Heikin-Ashi is a very reliable indicator, providing accurate results. It uses historical data, which is also quite dependable.
The indicator filters out market noise and reduces minor corrections making the signals more transparent. The smoothing effect makes it easier for trend identification. Markets are full of noise nowadays; hence, the Heikin-Ashi technique helps traders plan their entry and exit points more efficiently.
The Heikin-Ashi indicator can be combined with other technical indicators to give even stronger signals on market movement.
Cons
The use of historical prices where the signals of the Heikin-Ashi indicator are based on means that there is a time lag involved.
Most traders use price gaps to analyze price momentum, trigger entries, or position stop-loss orders. Although Heikin-Ashi lacks price gaps, traders can counter such a limitation during a trading session by temporarily switching to traditional candlesticks.
Heikin-Ashi data is averaged. Hence, it does not show actual open and close prices. It may not work well for day traders or scalpers with more active stocks.
Which chart type to choose?
I need all the open, close, high and low prices for my TA, so the line chart is too simple for me.
The OHLC bar chart has all the information as a candlestick chart. However, I want to trade candle- specific formations- such as the hammer, doji, or hanging man. So the bar chart is out.
The Heikin-Ashi chart has many advantages, but because of its cons, the candlestick chart is my favourite.
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bullrider_21
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