The Basics of Technical Analysis

Many analysts prefer candlesticks to bar charts because they feel that more information is presented. The reason for this is that the color and shape of the candlestick, relative to the previous candlesticks, gives an immediate visual snapshot of the day's trading and its relationship to the past. Price bars relay much of the same information, but its relationship to previous price changes is not considered as complete by itself in comparison. Volumes have been written about candlestick charting, so for the sake of brevity here, we'll concentrate on bar charts.

Volume is represented on a chart by a single bar directly below the price bar. It is adjusted according to quantity, meaning the number of shares that changed hands that particular day.

On the chart below, you can see both price bars and volume bars. The time axis, meaning the amount of time represented by the chart, is on the bottom line -- in this case, in days. The price axis runs up the upper right side, and it is the scale, in dollars and cents, by which we measure the stock. Through these, you can see the open, high, low and close of a stock's price on any particular day, plus its volume that day.

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Source: Quote LLC

Since I've mentioned the subject of time scale, this would be a good time to talk about time frames. Charts can be made for any number of time frames, from long term, such as annual, quarterly or monthly, to more intermediate term, such as weekly or daily, to extremely short term, meaning intraday in anything from one- to 120-minute increments. In each case, a single bar represents the chart's time period; for instance, on a daily chart, which is the most common chart, one bar equals one day.

Now let's take a look at these two things in action and get a very basic idea of what chart analysts look for.

Trends

First, technical analysts look at a chart to determine whether a stock is in an uptrend or a downtrend. This isn't a complicated process; in fact, one of my former colleagues said it was simple enough for his 5-year-old daughter to identify.

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Source: Quote LLC

Looking from left to right, is price going up or going down? Or is it just choppy? Simply take a pencil and draw a line from one swing point to another, and you'll have your answer.

What is a swing point, you ask? As you can see in the graphic, a swing point is when one price bar (or more than one with the same high/low price) is surrounded by two others that, in our graphic, are higher or lower than the high/low of the center bar(s).

So you find two swing point lows or highs, draw your line, and that's your trend line. Now you have a visual representation to show which way a stock is moving.

This brings us to the question of whether a trend line serves any purpose other than showing us something we probably already knew, namely the direction of the stock. The answer is yes.