Understanding different charts and when to use which one
There many charts that traders rely on to carry out technical analysis while trading the financial markets. The three types of charts that are widely used in forex markets are:
- Simple Line chart
- Bar chart
- Candlesticks
Let’s dive right in and scrutinize each one of them.
Simple Line chart
A simple line chart is the most basic charting type in forex trading. What happens in a line chart is that a dot is plotted for every closing price for a particular period. If it is an hourly chart, a dot will be plotted for the closing price after every one hour, while for a four-hour chart, a dot will be plotted for the closing price after every four hours.
A line is then drawn to connect the dots, making it possible for a trader to see general price movements within a given timeframe.
- Therefore, a simple line chart shows the general price movement from one closing price to the next closing price over a period of time. It is ideal for a fundamental trader, or a trend-following trader wishing to enter positions over a longer period.
The chart below is daily for the EUR/USD over several months.
Figure 1 A daily line chart for the EUR/USD currency pair Don't use plagiarised sources.Get your custom essay just from $11/page
Advantages of a simple line chart
- It gives a clear and straightforward view of the price movement, showing whether the market is falling or rising.
- It is ideal for a trader who wants to compare the performance of various stocks on the same chart due to its clearness.
Disadvantages of a simple line chart
- It doesn’t show how the market got at the closing price
- It lacks critical bits of information such as the Price-Open and high/low price levels that the market traded at.
- One cannot make a price-based decision using a simple line chart as it doesn’t show the trading range for a given period. One cannot determine whether the price momentum is a result of a bearish or bullish market.
When to use a line chart
Line charts are ideal for long-term analysis because they don’t show the daily highs and lows, hence giving a cleaner picture price movement overview over a long period. Line charts will be ideal for a trader intending to keep their positions open over a long period, usually a week and above, or for fundamental traders who want to get a more comprehensive simplistic overview of price movements.
Bar charts
A bar chart gives a solution to some of the shortcomings of a line chart. Unlike a line chart that only shows the price the market closed at and price movements, a bar chart shows the highest and the lowest price levels that the market traded, the opening price, and the closing price. That is why it is also called the OHLC chart, which stands for Open, High, Low, and Close. Below is the same EUR/USD chart that we had seen in the line chart above, looked at in a bar chart.
Figure 3 A vertical bar showing high, low, as well as open and close price
As you can see from the chart above, each bar in the bar chart has a left and right horizontal hash. The vertical bar itself shows the trading range for the currency pair. The opening price is indicated by the left-side hash, while the hash on the right indicates the closing price.
The top of the vertical bar indicates the highest price that a currency pair traded at, while the lowest price paid is shown by the bottom of the bar. A bar in the chart shows price movements over a given period depending on whether it is based on an hourly, weekly or daily chart.
If the left-side hash is below the right-side hash, it means that the market price closed higher than it opened; hence the value of the traded asset increased. On the other hand, if the left-side hash is above the right-side hash, it means that the market price closed lower than that it opened, meaning that the asset decreased in value.
Advantages
- At a glance, you can determine whether the market price closed higher or lower than it opened
- From the length of the bar, you can determine the strength or volatility of the trend
This type of chart rarely has a downside, and many traders and investors use it as it gives more information that enables traders to make price-based decisions. Use bar charts when you want to enter short-term positions that carry a risk of volatility because bar charts are more informative than line charts.
Candlestick charts
The most popular way to view a forex chart is by using a candlestick. An experienced trader will find it pretty more comfortable to use both candlesticks and bar charts to the same effect because both charts give you the same information in a slightly different graphical presentation. Unlike a bar chart, a candlestick adds color to the price information, making it easy to see the trend quickly. Below is the same EUR/USD chart that we had seen in the bar chart above, looked at in a candlestick chart.
What makes a candlestick chart simpler than a bar chart is that it has a body that is colored. The most commonly used color schemes are either green/red or white/black. If the body of the candlestick is colored green or white, it means that price rose during that period, and closed higher than it opened as illustrated below. A green or white candlestick is said to be positive.
A candlestick chart whose body is colored red or black indicates that prices fell during that timeframe, closing lower than it opened. A red or black candlestick is said to be negative.
Advantages
- Easy to interpret, especially for a new trader.
- They are easy to use due to the visual aid added by color schemes
- They make it easy to see market reversal points
Candlesticks are ideal for both new and experienced traders since they are easy to use and interpret. You are better off using candlestick charts if you tend to open and close positions in the same day because they provide a lot of visual aid to help you make quick price based decision with ease.