Understanding Stock Price Charts

Stock price charts graphically illustrate the movement of stock prices over time. The time period is charted on the X-axis (across), and the price is charted on the Y-axis (up/down).

Line Chart

There are three types of chart in common use: line, bar, and candlestick. A line bar represents the prices as points, connected by a line. Here is a sample of a line chart, graphing the closing prices for a stock:

Line chart - click to enlarge

As you can see, this chart gives a very clear and uncluttered view of the 'big picture', but it only captures the prices at one point in the day (in this case the close), so we don't know how the prices fluctuated throughout the trading session.

Bar Chart

We can overcome this drawback by switching to the next type of chart, the bar chart. Using this chart, we can capture four data points, the open, high, low, and close (so it's sometimes referred to as an OHLC chart). How do we capture four data points on one line? Well, the high is the highest point of the line and the low is the lowest, and then we have two 'flags' - extending to the left is the open price, and extending to the right is the close. Here's an example of the bar chart, covering the same period as the chart above:

Bar chart - click to enlarge

We can now clearly see a change in the volatility of this stock from the middle of June. The visual aspect is improved even more by the use of color - if the close is below the open, the bar is colored red, otherwise it is colored green.

Candlestick Chart

The third common chart type is called a candlestick chart. Candlestick charts are thought to date from 16th-century Japan, where rice traders used them to chart price fluctuations. They contain the same four pieces of data - open, high, low, and close, but the data are presented slightly differently, as you see below:

Candlestick chart - click to enlarge

Just like an OHLC bar chart, the high and low prices are represented by the high and low of the bar - on a candlestick chart we'd call this the 'wick'. The space between the open and close prices forms the 'body' of the candlestick. If close is above open, the body is empty (represented by white); if open is above close, the body is solid (represented by black). To the proponents of candlestick charting, this is not just another way of presenting the OHLC chart; they believe that a candlestick chart clearly shows patterns which can be used as reliable trading signals. There are twelve major signals, and over 40 minor ones. The good thing about them is that they usually have very descriptive and memorable names, for instance Gravestone Doji, Hanging Man, and Morning Star.
We don't have the space to do justice to this subject here, but if you would like to read further, Steve Nison's book on the right is considered the 'bible'.

Chart Period

You can alter the frequency with which each bar is 'printed'. A day trader will want to review one-minute or five-minute charts, whereas a long-term trend trader may just want to review weekly data. One excellent piece of advice with regard to time periods, given by Elder in his Triple Screen method but endorsed by others, is to always look at three different related timescales to support your trading decisions. So, for example, if you are a swing trader with a one to two-week holding period, your main chart timeframe would be daily. Elder suggests you step back one timeframe to ensure you are trading with the market, so review the weekly charts - is there any indication on this chart that sentiment is changing? If you feel that both the weekly and daily charts support an entry, you should go forward one timeframe to select the right entry point, so monitor the hourly charts.

Chart Scale

The 'normal' scale for a chart is called the linear scale. The relationships between prices are linear, so a $1 move is the same size at any point in the chart. However, sometimes this may not be desirable, as it may mask some significant moves - for instance, a $1 move from $2 to $3, a 50% increase, is quite different to a $1 move from $20 to $21, a 5% increase, but it would appear to be the same size move on a linear chart. An alternative scale is a logarithmic scale. On a logarithmic chart, a move from $2 to $3 would be the same size as a move from $20 to $30, i.e they are both 50% increases. Compare the two charts below (we've used line charts because they are less cluttered, but you can have logarithmic bar or candlestick charts too):

Linear chart - click to enlarge

Logarithmic chart - click to enlarge

Logarithmic charts are most useful when looking at longer timescales, as in the above example. You can clearly see that the accelerating price increase in 2006-7 shown on the linear chart is actually not accelerating - it is just continuing at the same, fairly-steady rate of increase starting in mid-2004.

Volume

Just reviewing prices with no reference to volume can sometimes be misleading, or can cause you to miss big 'clues' of an imminent change in market direction. For this reason, it's common practice to show volume of shares traded for the period at the bottom of the price chart, like this:

Candlestick chart with volume - click to enlarge

Note also the moving average of volume, the grey line superimposed on the volume bars. This gives an indication whether the day is above or below average for volume traded.

You can practice your chart-reading skills for free by playing this wonderfully addictive game from Matthias Wandel here.

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Copyright © 2011 Mick Brooks