Chapter 3
Introduction to Charts Part 1 & 2
From Charles D. Kirkpatrick II and Julie R. Dahlquist, Technical Analysis: The Complete Resource
for Financial Market Technicians, 3rd Edition
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Learning Objective Statements
➢ List Advantages of reviewing price information in chart format
➢ Review data points required to construct line, bar, and candlestick charts
➢ Describe how to construct line, bar, and candlestick charts
➢ Explain the differences between arithmetic and logarithmic scales and their uses
What is a chart?
A chart is the traditional tool of a technical analyst. Charts are merely graphical displays of data. In many countries,
technical analysts are called chartists although hand-drawn charts have somewhat become antiquated because
computers display and, in some programs, analyze the price data more quickly and efficiently. Nevertheless,
some specialists, floor traders, market makers, and technical analysts and analysis department of brokerages and
management firms still maintain hand drawn charts.
Charts help technical analysts recognize patterns and trends that can be useful in trading and investing. Of course,
the chart method is also subject to considerable criticism largely because the recognition of patterns and trends is
subjective, based on analyst’s skills and experience.
The benefits of chart use outweigh the problems associated with their interpretation.
Some benefits of using charts.
• Charts provide a concise price history – an essential item of information for any trader or investor.
• Charts can provide the trader or investor with a good sense of the market’s volatility- an important consideration
in assessing risk.
• Charts can serve as a timing tool, even by traders who base their decision on other information
(For example, fundamentals).
• Charts can be used as a money management tool by helping to define meaningful and realistic stop points.
History of Charts
The earliest known recording of commodity prices with the intent to predict from them was in ancient Babylonia in
the first millennium BC. These recording were diaries of traders and astronomers who were trying to correlate
astrology with price changes.
By the fifth and sixth century A.D, price charts, similar to those used presently, were developed in China, Europe,
and Japan. The Chinese were interested in cyclicality of prices; the Europeans were interested in astrology and
the Japanese developed candlestick chart that is still in use today. By the 1830s, just before the invention of ticker
tape for the stock exchanges, several chart vendors in New York sold published charts on stocks and commodity
prices.
Plausibly the type of chart was just a simple plot on paper of a number –either amount or price --and a date. In early
Japan, for example rice was traded by amount. Instead of a price per bag, it was the number of bags per price that
was recorded by famous rice trader Sokyu Honma in the 1750s. As market began to trade more frequently during
the day, the chart became more complex.
The invention of the ticker and the ticker tape revolutionized technical analysis and charting. Shortly after Thomas
Edison invented a machine called the Edison Telegraph Printer to print messages from a telegraph, in 1867 Edward A.
Calahan, an employee of the American Telegraph Company invented the ticker tape. Eventually it was improved
upon and patented by Thomas Edison in 1871.
A ticker tape is a device that shows stock symbols and numbers to convey information about trades. The ticker tape
is electronic today, but it gets its name from the ticking sound the original mechanical machine made and from the
long, narrow pieces of paper that stock quotes were printed on.
It is difficult to look at the 20 closing prices in the table to get an idea of whether the stock trend is up, down, or
sideways.
Now look at the figure on the right, the chart contains the same information. Notice how much it is easier to process
the information when it is provided in a picture format. As the old saying goes “A picture is worth a thousand
words.” With just a glance of the chart, you have a road map where prices have been; in fraction of a second, you
can easily spot the highest prices and lowest prices that occurred during the period. A chart quickly transforms a
table of data into a clear visual representation of the information.
What data is needed to construct a chart?
➢ During a normal trading day, many errors appear in the tape, from which most of the dates originates, that
someone must screen out and adjust. Some trade report or show the wrong price; some trades are in error and
must be broken; and some trades occur out of order.
➢ In addition to trading errors, other data errors can occur through stock splits, dividends, offerings and
distribution. In commodities markets, because contracts have a settlement date at which trading halts, incorrect
calculation of the time and price linkages between contracts may affect long term technical patterns and trends.
Calculation of these linkages into time series data for a longer term perspective is never precise. The results are
called either “nearest future”, “perpetual series”, or “continuous series” are provided by many data vendors and
exchanges.
What Type of Charts Do Analysts Use?
In early market, when the price of a security or good might be established only once or twice a day, the chart was
extremely simple.
It was a mere graph of closing prices connected by a line, sometimes directly connected and sometimes connected
by perpendicular lines. In Japan, this type of chart was called a “tome” chart from the word tome, which means
“close”. Today the three most common types of charts that record prices at a given time intervals (such as hourly,
daily, weekly, or monthly) are line charts, bar charts, and candlestick charts.
Let us look at each of these charts and others to see how they differ.
Line Chart
Line Chart…
Line charts, however, can be used to present data collected at any time interval. More frequent data collection will
lead to a more detailed at any time interval. More frequent data collection will lead to a more detailed, but more
Cluttered, graphical representation.
For example compare the above charts, each of these charts represents trading data for APPL(Apple Computer) over
the 22 months from July 2013 through May 2015. The first chart uses daily data, the second chart displays weekly
data, and the third chart represents monthly data.
Bar Charts
Although the line chart visually displays one piece of information for each
time in interval, a bar chart shows at least 3 pieces of information: the
high, the low and the closing price for each time interval. Some bar charts
also contain a fourth piece of information: the opening price.
Each time interval (that is, day, week, or five-minutes) is represented by one
bar. The top of this vertical line represents the highest price at which the
security traded on that day; the bottom of the bar represents the lowest
trading price of the 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 on the
right side of the bar indicated the closing price for the day. If the opening
price for the day is recorded by a small tick mark to the left side of the bar.
The difference between the high and low price in any bar is called the
range.
Another quick observation is that bar for trading on a 5 day has lower high
than the low of day 6. This space is called gap. Thus the bar chart makes it
easier to spot changes in trend and price action from bar to bar, certainly
more easily than the column of numbers you saw previously.
Candlestick Charts
Candlestick charts originated in Japan.
These techniques have been widely used in the Far East
for many generations, but not until the publication of the
Book Japanese Candlestick Charting Technique by Steve
Nison in 1991 were western traders introduced to
candlestick charts. Today, almost every technical analysis
software package and and technical service offers
candlestick charts. You can even create candlestick charts
through the charting options in excel.
Candlestick charts are similar to bar charts in their
construction. To construct a candlestick chart, the low and
high prices are plotted on a thin bar, just as they would be
for the chart that we discussed. A box is used to represent
Source: Investopedia the opening prices and the closing prices. To create this
box, a horizontal mark is made at both the opening and
closing prices; a rectangle is formed using these two
horizontal marks.
The rectangular box is called the real body of the
candlestick.
Candlestick Charts…
If the security closed at a higher price than it opened, the real
body is white (gray in the charts here) or open. These white or
“open” real body candlesticks indicate price advances from the
opening.
Conversely, if the closing price falls below the opening price,
the real body of the candlestick is shaded black. These
candlesticks with a “closed”, or black, real body designate price
declines from the opening.
The thin vertical bars, representing the price extremes of the
trading session, are called the shadows. The shadow above the
real body is called the upper shadow; the shadow below the real
body is called the lower shadow. The real body will look like a
candle and the upper shadow will look the wick.
Individual candlesticks can take on variety of interesting sizes.
Some have long shadows; others have short shadows.
Some have tall boxes; other have short boxes. The color of the
box, the length, the lengths of the boxes and shadows, and where
the box sits relative to the shadows tell something about the
trading that occurred over the time period represented by the
candlestick.
Types of Scale
1) Arithmetic Scale
➢ For all the charts we have examined so far, along with
most technical analysts, we have used arithmetic (or
linear) scales.
➢ A plot with an arithmetic scale, shows how price units
along the vertical scale at the same price intervals.
➢ For example, the vertical plot distance of a change of
$1 to $2 would be the same as the plot distance from 10
to 11 or 100 to 101.
➢ In other words, using regular evenly divided grid paper,
we plot each box vertically as the same dollar amount.
2) Semi-logarithmic scale
➢ Although the arithmetic scale is the scale most often used,
sometimes adjustments need to be made, especially when
observing long-term price movements.
➢ A logarithmic price scale will show different vertical movement
for the changes in price between $10 and $15 and the change in
price between $20 to $25. While both are the same dollar amount
move, the first $5 change represents a 50% increase in the asset's
price. The second $5 change represents a 25% increase in the
asset's price. Since a 50% gain is more significant than 25%,
chartists will use a larger distance between the prices to clearly
show the magnitude—known as the orders of magnitude—of the
changes.
➢ The rule of thumb for when to use an arithmetic or logarithmic
scale is what when the security’s price range over the period
Being investigated is greater than 20%, a logarithmic scale is
more accurate and more useful. As a rule, the long-term charts
(more than a few years) should always be plotted on logarithmic
scales.
