There is no doubt in my mind, that head and shoulders above all the charting methods, candlestick charting is the best method that has been adopted by many of the most successful traders. I read somewhere that anyone who has read and understood candlestick charting will never revert to any other charting format. Of course, one of the most important factors that I stress time and time again to those I coach, is that knowledge is one thing, implementation is everything!
Warren Buffett once said “Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” There was a time when anyone who was interested in forex trading was forced to contact his broker. The last 30 years have brought that to an end. Now many people outside of the financial industry could have the ability to trade. How things have changed. The techniques in use now are a million miles away from the techniques used barely 25 years ago. This also applies to forex charting methods. Once again Warren Buffett (yes, he is one of the worlds greatest businessmen) said “In the business world, the rear-view mirror is always clearer than the windshield.” That is why understanding your charts and being able to use them in to trade is such a useful tool Historically there have been four different chart type:
- Point and Figure Charts
- Line Charts
- Bar Charts
- Candlestick Charts
Let us review the basic elements of each chart type.
Point and Figure charts
The technique of using Point and Figure Charts is over 100 years old. “Hoyle” was the first to write about it and showed charts in his 1898 book,” The Game in Wall Street.” This technique for charting was often filled in at the end of the day by traders. This was one of the first charting strategies to be computerised in the 1960’s. This technique is also known as the tick tack toe charting method. Point and figure charting is different to all the other charting techniques that are used in that it does not plot price against time as all other techniques do. Instead it plots price against changes in direction by plotting a column of “X’s” as the price rises and a column of “O’s” as the price fall. A point and figure chart does not record anything if the price remains unchanged. This is a fundamental difference to other charts.
A line chart is simple line chart draws a line from one price to the next similar price. This may be either the opening, closing, high, low or average price. For each time period these points are connected with a line, we can see the general price movement of a currency pair over a period of time.
A Bar Chart is also known as an “OHLC” chart as it shows the opening price, the high price, the low price and the closing Price all within a given period. This period may be as short as a second (not recommended) or as long as a year. That is why it is very important to understand the time period that you are trading in. A bar chart is a little more complex than a line chart. It shows the opening and closing prices, as well as the highs and lows. It is composed of a single vertical bar with two small horizontal bars (if you a can see the letter “t” without the hook at the bottom and the horizontal bar split so that one half appears on the left side of the vertical line whilst the other side appears on the right hand side but higher or lower than the left hand bar).
The bottom of the vertical bar indicates the lowest traded price for that time period, while the top of the bar indicates the highest price paid. The vertical bar itself shows the currency pair’s trading range for the whole duration of the selected time frame. The horizontal bar on the left side of the bar is the opening price, and the right-side horizontal hash is the closing price. A bar is simply one segment of time, whether it is one day, one week, or one hour. When you see the word ‘bar’ going forward, be sure to understand what time frame it is referencing.
Candlestick chart show the same information as a bar chart, but in a much more user-friendly format. Candlestick bars still indicate the high-to-low range with a vertical line. However, in candlestick charting, the larger block (or body usually displayed as a rectangular vertical shape) in the middle indicates the range between the opening and closing prices. Traditionally, if the block in the middle is filled or coloured in, then the currency closed lower than it opened. This was how candlesticks were implemented by the financial institutions in the early days of computing. Nowadays where the price at any given moment is higher than the opening price, the box is filled in green.
Where the present price is lower than the opening price the box is filled in red. The great advantage of using the colours is that candlesticks allow the traders to “see things on the charts much faster, such as up-trends / down-trends and possible reversal points. It is this visual appearance which is so popular with traders. Visually the candlesticks present the exact same information as appears on an OHLC bar chart. Louis Pasteur, the famous Chemist and Microbiologist once said that “In the fields of observation, chance favors only the prepared mind.” I have no doubt that those who use Candlesticks for charting have a prepared mind and are a few steps ahead of the forex trading pack compared to those who do not.