Introduction: Chart Construction

INTRODUCTION

This chapter is primarily intended for those readers who are unfa­miliar with bar chart construction. We'll begin by discussing the different types of charts available and then turn our focus to the most commonly used chart—the daily bar chart. We'll look at how the price data is read and plotted on the chart. Volume and open interest are also included in addition to price. We'll then look at other variations of the bar chart, including longer range weekly and monthly charts. Once that has been completed, we'll be ready to start looking at some of the analytical tools applied to that chart in the following chapter. Those readers already familiar with the charts themselves might find this chapter too basic. Feel free to move on to the next chapter.

TYPES OF CHARTS AVAILABLE

The daily bar chart has already been acknowledged as the most widely used type of chart in technical analysis. There are, how­ever, other types of charts also used by technicians, such as line charts, point and figure charts, and more recently, candlesticks. Figure 3.1 shows a standard daily bar chart. It's called a bar chart because each day's range is represented by a vertical bar. The bar chart shows the open, high, low, and closing prices. The tic to the right of the vertical bar is the closing price. The opening price is the tic to the left of the bar.

Figure 3.2 shows what the same market looks like on a line chart. In the line chart, only the closing price is plotted for each successive day. Many chartists believe that because the closing price is the most critical price of the trading day, a line (or close- only) chart is a more valid measure of price activity.

Figure 3.1 A daily bar chart of Intel. Each vertical bar represents one day’s action.

Figure 3.2 A line chart of Intel. This type of chart produces a solid line by connecting the successive closing prices

A third type of chart, the point and figure chart, is shown in Figure 3.3. Notice here that the point and figure chart shows the same price action but in a more compressed format. Notice the alternating column of x's and o's. The x columns show rising prices and the o columns, declining prices. Buy and sell signals are more precise and easier to spot on the point and figure chart than on the bar chart. This type of chart also has a lot more flexibility. Chapter 11 covers point and figure charts.

CANDLESTICKS

Candlestick charts are the Japanese version of bar charting and have become very popular in recent years among western chartists. The Japanese candlestick records the same four prices as the traditional bar chart—the open, the close, the high, and the

Figure 3.3 A point and figure chart of Intel. Notice the alternating columns of x’s ad o’s. The x column shows rising prices. The o column shows falling prices. Buy and Sell signals are more precise on this type of chart.

low. The visual presentation differs however. On the candlestick chart, a thin line (called the shadow) shows the day's price range from the high to the low. A wider portion of the bar (called the real body) measures the distance between the open and the close. If the close is higher than the open, the real body is white (posi­tive). If the close is lower than the open, the real body is black (negative). (See Figure 3.4.)

The key to candlestick charts is the relationship between the open and the close. Possibly because of the growing popular­ity of candlesticks, western chartists now pay a lot more attention to the opening tic on their bar charts. You can do everything with a candlestick chart that you can do with a bar chart. In other words, all the technical tools and indicators we'll be showing you for the bar chart can also be used on candlesticks. We'll show you a bit later in the chapter how to construct bar charts for weekly

Figure 3.4 A candlestick chart of Intel. The color of the candlestick is determined by the relationship between the open and the close. White candlesticks are positive, while black candlesticks are negative.

and monthly periods. You can do the same with candlesticks. Chapter 12, "Japanese Candlesticks," provides a more thorough explanation of candlestick charting.

ARITHMETIC VERSUS LOGARITHMIC SCALE

Charts can be plotted using arithmetic or logarithmic price scales. For some types of analysis, particularly for very long range trend analysis, there may be some advantage to using logarithmic charts. (See Figures 3.5 and 3.6.) Figure 3.5 shows what the differ­ent scales would look like. On the arithmetic scale, the vertical price scale shows an equal distance for each price unit of change. Notice in this example that each point on the arithmetic scale is equidistant. On the log scale, however, note that the percentage

Figure 3.5 A comparison of an arithmetic and logarithmic scale. Notice the equal spacing on the scale to the left. The log scale shows percentage changes (right scale).