Introduction to Charting and Technical Analysis: When it comes to making money trading stocks, the two most crucial factors that traders should know is how to read charts and how to perform technical analysis. Both these strategies go hand-in-hand for the traders.
In this article, we are going to look at the basics of Charting and Technical Analysis, and understand how this deadly combination can help traders make consistent profit from their trades. Keep Reading!
Charting and Technical Analysis
Before we get deeper into Charting and Technical Analysis, first of all, let us understand what is Technical Analysis (TA) and what is Charting in the stock market.
What is Technical Analysis (TA)?
Technical Analysis (TA) can be used by both traders and investors for entering and exiting into any trade. It provides a means to have a stronger conviction about the trade. To put it in simple words, technical analysis is a medium via which we try to look at the past or historical data, and based on that make an informed judgment about the future price movement.
The tools used for performing technical analysis have been developed with years of practice and application on the financial market. TA is a form of Statistical tool which helps us in understanding the trends gathered from information like the price movement and volume
The oldest form of Technical Analysis!
The oldest known form of Technical Analysis is Candlesticks. It was used in the 18th century, to measure the price movement of Rice. Candlesticks are still the most reliable and commonly used technical analysis charting tool.
The objectives behind using Technical Analysis
- To understand the trend and predict the price movement.
- To understand the various Single Candlestick and Multi Candlestick patterns and take a trade based on them.
- To understand the right entry price for the asset, which one intends to trade.
- To ascertain and find the right Stop Losses for the trade.
- And, most importantly, to spot the trading opportunities.
Logical expectations while using Technical Analysis
While trading in stocks or any other assets, here are logical expectations that trades should expect with technical analysis:
- Don’t expect miracles. One should be as realistic as possible regarding the expected rewards from the trades.
- Helpful in trading but not for investing. This is very important because technical indicators give signals which are for a short duration of time while Investing, in general, is for a long duration of time.
- One should enter and exit the trades as decided at the time of entering a trade by using TA. This will help in Risk Management and keep emotions out of trading.
What is Charting?
If one were to do any form of technical analysis, charting is the most reliable form of tool which is used for performing Technical Analysis.
There are generally three forms of charting tools – Line charts, OHLC Charts (Open, High, Low, and Close), and the Candlesticks charts.
1) Line Charts – This is the simplest form of charting tool. This chart is the easiest to construct. To construct this chart, the daily closing price is plotted on the chart and then a line is drawn by connecting all these points.
The one drawback with this charting formation is that only the closing price is given weightage and the daily price action is given no weightage. Therefore, this form of charting tool is not used by traders, but it is very commonly used by investors.
Now, if you look at the charts above, it can be seen the line is formed by joining the closing price for the day and it gives us a general idea of the trend but does not give any indication about the price action of the day.
2. OHLC Charts – As suggested by the name, this form of charting pattern is more complicated than Line charts. All the information like the Open, High, Low, and close is available on the chart. Even the daily range can be easily ascertained from these charts. These charts are used while trading and not investing.
Now, if we were to look at the image above, we clearly see the candle giving information like the open, high, low, and close. If the candle is green in color, then we can interpret that the open of the candle is below the close of the candle and the day has belonged to Bulls. And vice-versa, if the open of the candle is above the close of the candle.
3. Candlesticks – As mentioned earlier, this is the oldest form of charting pattern which is used for trading purposes. Just like the OHLC charts, even the candlesticks show the Open, High, Low, close, and range for the day. But, where the candlesticks chart stands out against the OHLC chart is the visual appeal of the chart. Candles are easier to comprehend, as against any other charting methods.
Now, in the image above, a classic candlestick chart is shown. And just by having a quick glance, the overall sentiment of the market can be ascertained. And this feature of visual appeal and being interactive makes this chart trader friendly.
Charting and Technical Analysis – A Match Made in Heaven
Now, a complete trader is one who is able to understand the technical factor and is able to use his charting knowledge to form a judgment about the stocks to invest in, and also the right time of entry and exit for the trade.
A complete trader has the following traits:
- Picking the right stocks by looking at the current scenario. And at any moment, good knowledge of the technical analysis goes a long way in picking the right entry price for the trade.
- He/She is very good at managing their risks.
- Overtrading is one trap in which a lot of traders, end up losing a lot of money that they have made by taking very good trades. So, a complete trader avoids the honey trap of overtrading and takes trades that qualify his trading discipline.
- And most importantly, it is important to have good and complete knowledge about the technical indicators. And the best way to go about doing it is by applying on the markets.
- It is advised for the beginners, to take it slow and risk small about of the portfolio, while investing and always have proper risk management for having a long and prosperous trading career.
That’s all for this article on the basics of Charting and Technical Analysis. We hope you have got an elementary idea of both Charting and TA through this post. Do comment below which is your technical analysis tool while trading in stocks. Happy Trading and Money Making !!
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!