Knowing how to read the trading charts can be one of the most important skills in a trader’s repertoire. For a novice learning to trade or for a professional refining their approach, chart analysis is essential knowledge that provides a deep understanding of how markets work.
With the right approach, one can clearly define market trends and predict prices for the future, thus charting a course toward making better and more informed decisions in trading. This tutorial aims to look at three of the basic principles to get you started in the understanding of price action in the markets using candlesticks, trends, and indicators on trading charts.
What is a Trading Chart?
A trading chart is simply a chart plotting price against time. The chart plots the fluctuations of an asset’s price it a stock, currency pair, or commodity. These charts are used by traders to study past data and predict future market movements. There are many different types of trading charts, and the candlestick chart is probably one of the most popular since it can convey quite valuable information about price action in a concise and easy-to-read format.
First, before getting into the core elements of trading charts, let’s look at why they’re important:
- Price Action Insight: The chart will allow you to visually see the movement of price, trends, and possible reversals.
- Timing Entry and Exit: By understanding the patterns and indicators on a chart, you can identify the best entry and exit points for your trades.
- Market Sentiment: Charts help traders gauge the market sentiment-whether buyers are in control, bullish, or sellers are dominating, which is referred to as bearish.
Understanding the elements of trading charts can empower you to take more control of your trading decisions and reduce the guesswork involved in analyzing the market.
Candlestick Charts: Understanding the Basics
Candlestick charts are widely used in trading for visualizing price action. Each candlestick provides four essential pieces of information:
- Open Price: The price at which an asset begins trading during a given time period.
- Closing Price: The price at which the particular asset stops trading at the end of the period.
- High Price: Maximum of the highest prices within a given period.
- Low Price: Minimum of the lowest prices within a given period.
The body of the candlestick is between the open and close price of the candle; the wicks extend from it, reaching up and down from the body towards the high and low reached for the period. The color of the candlestick depicts the move of the market:
Bullish Candlesticks: If the closing price is higher than the opening price, then the color of the candlestick usually appears as green or white. This chart indicates that the price has increased over the period.
Bearish Candlesticks: If the closing price is lower than the opening price, then the color of the candlestick usually appears as red or black. This chart indicates that the price has fallen over the period.
Candlestick Patterns:
Combinations of one or more candles forming candlestick patterns hint about future market movement. The important candlestick patterns include:
Doji: In a Doji candle, there is a very small body while the wicks are very long. It essentially signals indecision in the market. A doji could signal a possible reversal if formed at the end of a trend.
Hammer: The hammer is a bullish reversal pattern wherein the downtrend may be broken.
Engulfing Pattern: A bullish engulfing pattern comprises a smaller bearish candlestick followed by a larger bullish one. This gives a strong indication of an upward move.
All these patterns give the trader the ability to anticipate the direction which the market might take and enable them to take the right entry or exit of a position in the market.
Identifying Trends: The Direction of the Market
The first fundamental is to define in which direction the market is heading. Markets take one of these three trends:
Uptrend – Bullish Market: An uptrend is established if the market marks higher highs and higher lows. During an uptrend, price is moving up over time and traders are generally looking for buy orders.
Downtrend – Bearish Market: A downtrend shows lower highs and lower lows. During a downtrend, the price is falling, and traders look for selling opportunities or short positions.
Sideways Trend – Range-bound Market: It is where the price moves sideways, going neither high nor low. Normally, a range trading strategy is applied by traders in case of range-bound markets. In the ranges, the traders will always take advantage of bounces between support and resistance levels.
Trendlines and Channels:
Trendline refers to a straight line that connects two or more points in the chart. The concept aids in highlighting the trend’s direction, plus where potential reversal could be considered.
Uptrend Line: In the case of an uptrend, the trendline is drawn by connecting the lows of the price action to identify the direction of support.
Downtrend Line: The trendline in a downtrend is drawn by connecting the highs of price action so that the direction of resistance can be measured.
Channels are formed when the price action is sandwiched between two parallel trendlines. A channel helps a trader to define what area the price will most likely fluctuate within.
Indicators: Sharpening Up Your Chart
While candlesticks and trends are great ways to view information, many traders use technical indicators to confirm their analysis and further refine their strategies. Indicators are mathematical calculations based on price, volume, and open interest data, and they help identify trends, volatility, momentum, and market strength. Let’s explore some of the most commonly used trading indicators:
1. Moving Averages
Moving averages smooth out the noise in price action over a selected period. They help define the direction of the overall trend. Simple Moving Average: The SMA is calculated by taking an average of the closing prices within a certain period. It’s usually used in determining the level of support or resistance.
Exponential Moving Average (EMA): The EMA gives more weight to recent prices, making it more responsive to market changes. It is widely used for identifying short-term trends.
2. Relative Strength Index (RSI)
The Relative Strength Index measures the magnitude of recent gains relative to recent losses, so one knows how strong a price move is. It moves between 0 and 100 and will show overbought conditions above 70 and oversold positions below 30. Many traders will use it to find probable reversal points.
3. Moving Average Convergence Divergence (MACD)
The MACD accounts for the relationship between two moving averages of the price of an asset. It is also called the MACD line, which is the difference between the 12-day and 26-day EMAs. These help in highlighting potential buy or sell signals when the MACD line crosses the signal line-the 9-day EMA. MACD fairs very well in picking up any bullish or bearish trend.
Conclusion: Putting It All Together
Reading the trading charts is one of the most critical skills that one needs to make it in this world of trade. By knowing the candlestick patterns, trend identification, and using indicators that enhance your analysis, you’ll be better prepared to make smart and profitable trading decisions.
The best practice is studying charts, identifying trends, and using indicators to confirm your trading strategy. As you get some experience, you start to have more knowledge on reading charts, and your level of confidence with respect to your trading decisions also goes up. It’s all about a process of trading; you’ll go well in life with the proper equipment.
