Trading 101: How to Choose the Right Chart Type
Chart reading and pattern trading is something we have talked a lot about in this section in the past. Still, a question many new traders may have is perhaps what type of chart is the best to use in their daily trading. Do some charts work better with technical analysis than others?
Japanese candlestick charts
The Japanese candlestick chart is probably the most common chart type to use among those who have at least some experience with trading (not investing).
Japanese candlestick charts were, as the name implies, developed by the Japanese back in the 18th century for trading with rice futures. Today, this chart type has gained recognition among traders around the world for all the data that it represents in a visual and easily understandable way.
The way the candlesticks work is that each bar in the chart represents four pieces of price information for the chosen timeframe: opening price, closing price, highest price, and lowest price.
The lines above and below the “body” of the candles are called wicks. Generally, candles with long wicks signals indecision by the market, and candles with longer body’s signals more decisive movements by the market.
OHLC is short for open, high, low, close, and consists of vertical bars with horizontal lines sticking out on the sides. They represent the same information as Japanese candlesticks, but in a slightly different way.
The straight vertical lines in this chart type represents the distance between lowest and highest price during the chosen timeframe. Again, a green line means that the closing price was higher than the opening price, and red lines vice versa. Opening (left side) and closing prices (right side) are indicated by the short horizontal lines sticking out on the sides.
A line chart is the simplest of all types of charts, and is often preferred by long-term investors, financial media outlets, and people who have little to no experience with trading and investing.
Line charts are usually not used by traders because they only represent a small piece of the available price data, namely the closing prices for each time period that we have set the chart to. In other words, we will not find out anything about opening prices, highs and lows within each time period when looking at a line chart.
Despite this, there are cases where even advanced traders choose to use line charts because they can provide more clarity to the market. For example, certain chart patterns such as the ABC (aka. 123) pattern stands out much more clearly when using a line chart. If you try it out, you may also find that other well-known patterns like the head & shoulder stand out very clearly on line charts.
Lastly, we’ll go over the least common of these chart types: the renko chart. As with the classic Japanese candlestick chart, this chart type was also developed by the Japanese.
Renko charts are designed to filter out smaller price movements in order to focus on the bigger picture in the market. The first thing to understand about this chart is that each “box” or candle represents a certain price movement rather than a time period, as for other chart types.
When the trader sets up the chart, he can define how large of a price movement each box in the chart should represent, and the chart will print new boxes, either red or green, as the price moves beyond the chosen parameters. This means that when prices consolidate and move only sideways, no new boxes will be printed on the chart.
The main use for renko charts is in identifying important support and resistance zones when you need to filter out all other less important things in the market. It can also be an effective tool for spotting trends and reversals in the market, but usually in combination with Japanese candlestick charts to ensure you are not missing out on important price information.
Japanese candlesticks best for all-round use
In summary, use line charts whenever you need a clearer view of the price action and to “unclutter” the charts. For most other uses, Japanese candlesticks will give you the best and most accurate representation of the price. Other chart types should be used only if you have specific trading strategies that require the use of those chart types.
Featured image from Pixabay.