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Knowledge

Base  Articles

Basics of Charting and Technical Analysis

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Price Chart

A price chart is a sequence of prices plotted over a specific timeframe. In statistical terms, charts are referred to as time series plots. On the chart, the y-axis (vertical axis) represents the price scale and the x-axis (horizontal axis) represents the time scale. Prices are plotted from left to right across the x-axis with the most recent plot being the furthest right.

Technical Analysis

Technicians, technical analysts and chartists use charts to analyze a wide array of securities and forecast future price movements. The word “securities” refers to any tradable financial instrument or quantifiable index such as stocks, bonds, commodities, futures or market indices. Any instrument with price data over a period of time can be used to form a chart for analysis.

While technical analysts use charts almost exclusively, the use of charts is not limited to just technical analysis. Charts provide an easy-to-read graphical representation of a instrument’s price movement over a specific period of time.

Time Intervals

A graphical historical record makes it easy to spot the effect of key events on a instrument’s price, its performance over a period of time and whether it’s trading near its highs, near its lows, or in between. The timeframe used for forming a chart depends on the compression of the data: intraday, daily, weekly, monthly, quarterly or annual data. The less compressed the data is, the more detail is displayed.

Intraday data is made up of prices at which the trading takes place throughout the day, it is also called tick-data if the prices are for individual trades, rather than compressed in a minutely open-high-low-close format. Daily data is made up of intraday data that has been compressed to show each day as a single data point, or period. Weekly data is made up of daily data that has been compressed to show each week as a single data point. The more the data is compressed, the longer the timeframe possible for displaying the data. The choice of data compression and timeframe depends on the data available and your trading or investing style.

Daytraders usually concentrate on charts made up of intraday data to forecast short-term price movements. The shorter the time frame and the less compressed the data is, the more detail that is available. While long on detail, short-term charts can be volatile. Large sudden price movements, wide high-low ranges and price gaps can affect volatility.

Daytraders might use a combination of long-term and short-term charts. Long-term charts are good for analyzing the large picture to get a broad perspective of the historical price action. Once the general picture is analyzed, an intraday chart can be used to zoom in.

Chart Patterns

The hills and valleys, shapes and curves that develop over time on a chart are found to have predictive value for future market direction. Patterns can either indicate a reversal or a continuation of an existing trend.

The pattern recognition can be open to interpretation, which can be subject to personal biases. To defend against biases and confirm pattern interpretations, other aspects of technical analysis should be employed to verify or refute the conclusions drawn. While many patterns may seem similar in nature, no two patterns are exactly alike. False breakouts, bogus reads and exceptions to the rule are all part of the ongoing education.

Reversal patterns

Often take a longer time to form on the chart and represent changes in trend. The larger the pattern, the greater the potential price movement. The height of the pattern measures volatility, while the width measures time required to complete the pattern. (Patterns at market tops are usually more volatile and shorter in time than bottoms.) Remember, a trend must exist for the pattern to be valid, and breaking a major trend line does not necessarily indicate a trend reversal (it might be the beginning of a sideways trend).

Continuation patterns

It suggests that a market is only pausing for a while before the prevailing trend will resume. Continuation patterns are usually shorter-term in duration than reversal patterns and are often classified as intermediate-term chart patterns. Their signals often coincide with momentum and trend indicators. These patterns have the same predictive value within a chart of any time frame.

Let see some of the more common reversal patterns include head-and-shoulders, double tops and double bottoms and saucers. Some of the most common continuation patterns include: flags, ascending and descending triangles, pennants, gaps, and rectangles.

Summary

The keys to successful chart analysis are dedication, focus and consistency.

· Dedication: Learn the basics of chart analysis, apply your knowledge on a regular basis and continue your development.
· Focus: Limit the number of charts, indicators and methods you use. Learn how to use these and learn how to use them well.
· Consistency: Study your charts on a regular basis and study them often (daily if possible).

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