In this post we will review the different types of charts you can use to perform technical analysis on foreign exchange (forex) currencies. Although we are focusing on forex technical analysis, the fundamentals can also be applied to equities, futures, and ETFs.
Technical analysis at its most basic form is the interpretation of charts through patterns and indicators to identify entry and exit points for a given trade. It’s no different than reading a sales report; you just need to understand the terminology and the product of the sales report.
There are three chart types used in technical analysis: candlestick, bar, and line charts. Candlestick charts provide the most information of the three types.
Below are examples of the 3 types of charts.
The line chart is the most common chart seen on financial shows, and is also the most basic of the three charts. This chart is created by connecting a series of pricing data such as the Open, High, Low or Close of the currency pair (as well as equity charts). The data series is constant and cannot be “mixed”: in other words, you cannot have a combination of Open price data and Close price data drawing the chart line. As you can see by the chart example above, the line chart provides the price trend, but not much more.
Bar charts provide technical traders with some additional information compared to the line chart. Looking at the chart above we find that a bar represents a period of time; in this case each bar represents one day or 24 hours (remember currency markets are open 24 hours a day, seven days a week).
Each bar provides traders with the Open, the Close, and the High and Low bar, in this case of the day. The top of the bar is the High and the bottom of the bar is the Low. The left hash bar, or horizontal bar, represents the Open and the right bar represents the Close. A Daily bar will open at 17:00 EST U.S. time as the previous Daily bar closes at the same moment.
The bar formation provides the trader with additional information such that the trader can tell if the currency pair continued in an upward trend or downward trend by looking at the level of the hash bars. If the right hash bar is higher than the left hash bar the trend was moving higher, and the closer to the top of the bar the hash bar is the more bullish the move. The same holds true for the opposite on a downward trend.
Now let’s take a look at the candlestick chart. The candlestick chart is the most popular and widely used in technical analysis because of the amount of information it provides. It’s sometimes called Japanese Candlesticks because Japanese rice growers wanted to easily track the price of rice in a single picture long before computers were around.
Once traders learn how to read a candlestick it will become clear how useful these charts can be; in fact even if you have never seen one before reading this you’ll notice how easy it is to locate the trend.
Just based on the colors of the candlestick it’s easy to determine if the currency pair was up or down for the day. Now in the example above the green candle is a bullish day and the red is a bearish day, however, many charting programs also use blue or white for bullish day and black for bearish day. Some charting packages even allow the user to change the colors at will. For our purposes let’s stick with green and red for now.
It’s also apparent just by glancing at the chart if there is a trend or momentum in a particular direction by a series of red or green candles.
But the color of the candle adds an extra element of readily discernible directional bias, and notice how the body (the candle) and the lines below and above the body (the wicks) play key roles in candlestick formations or patterns.
It’s this additional information that makes candlestick charts the preferred charts for currency traders and technical traders in any market.
A green bullish candle closes higher than it opens, the top of the candle’s body is where the price closed, and the bottom of the body is where the price opened.
With a red bearish candle the top of the body will be where the pair opened during that time frame, and the bottom of the body will be where the pair closed.
A candlestick chart can represent any timeframe all the way down to one minute. Typically candlestick charts will not be used much lower than a minute and never at the tick level due to its construction.
Next up in our series we will look at determining the trend.