Phase 5: Learn To Read Charts
Charts play integral role in successful Forex Trading. More you learn charts, more you trade in profits. Therefore, it need a lot of time to read charts carefully. Let us try to understand the charts in simple words. Only tool for technical analysis is chart which helps to see the rise and fall in prices. Charts help in trading. In other words, charts informs when to sell or buy any currency or when to open or close any trade. To use charts in trading, we have to understand the following:
- Types of Charts
- Chart Patterns
1) Types of Charts
There are 4 types of charts to see the prices.
- Line Chart
- Bar Chart
- Candle Stick Chart
- Points and Figure Chart
Each of these charts have pron and cons. Every trader observe the charts by their mean and understanding. Majority of the traders use Candle Stick Chart type.
1.1) LINE CHART: The most basic type of chart is Line Chart. This charts is used very often in Forex Trading. In this chart, prices are displayed in the form of lines. This chart displays only Closing Price. This chart helps to see the overall trend of the currency and market. As an example. see below:
1.2) BAR CHART: Bar chart is used more as compared to Line chart. This chart displays prices in the shape of bar. This chart displays not just Closing Price, but it also provide date for Opening Price, High Price and Low Price. Rise and Fall in the prices can be observed more easily through Bar chart.
1.3) CANDLE STICK CHART: Few centuries ago, Japanese introduced this kind of chart. Majority of the traders like this chart and use it for their observations. This char is most easy to understand. In candle stick chart, prices are displayed in the form of boxes that informs Opening Price, Closing Price, High Price and Low Price. It is very easy to read rise and fall of prices through this chart.
1.4) POINTS AND FIGURE CHART: The point and figure chart is not well known or is least used by the traders. The point and figure chart removes the insignificant price movements, in the stock, which can distort traders views of the price trends. In this chart, the Xs represent upward price trends and the Os represent downward price trends.
2) Chart Patterns
There are many chart patterns that traders uses in Forex Trading. We briefly described the famously used patterns below:
- Head and Shoulders (H&S)
- Double Top
- Double Bottom
- Engulfing Pattern
- Hanging Man
2.1) HEAD AND SHOULDERS (H&S): This pattern is trad-able because it provides an entry level, a stop level and a profit target. H&S pattern can be a topping formation after an uptrend or a bottoming formation after a downtrend. A topping pattern is a price high followed by retracement, a higher price high, retracement and then a lower low. The bottoming pattern is a low, a retracement followed by a lower low (head) and a retracement then a higher low. The pattern is complete when the trend-line, which connects the two highs (bottoming pattern) or two lows (topping pattern) of the formation, is broken.
2.2) TRIANGLES: Triangles are very common, especially on short-term time frames and can be symmetric, ascending or descending. It is trad-able pattern because the pattern provides an entry, stop and profit target. The entry is when the perimeter of the triangle is penetrated. The stop is the low of the pattern. The profit target is determined by adding the height of the pattern to the entry price. While the patterns appear slightly different for trading purposes there is minimal difference.Triangles occur when prices converge with the highs and lows narrowing into a tighter and tighter price area.
2.3) DOUBLE TOP: The double top pattern is found at the peaks of an upward trend and is a clear signal that the preceding upward trend is weakening and that buyers are losing interest. Upon completion of this pattern, the trend is considered to be reversed and the security is expected to move lower. The first stage of this pattern is the creation of a new high during the upward trend, which, after peaking, faces resistance and sells off to a level of support. The next stage of this pattern will see the price start to move back towards the level of resistance found in the previous run-up, which again sells off back to the support level. When using this chart pattern one should wait for the price to break below the key level of support before entering.
2.4) DOUBLE BOTTOM: This is the opposite chart pattern of the double top as it signals a reversal of the downtrend into an uptrend. This pattern will closely resemble the shape of a W. The double bottom is formed when a downtrend sets a new low in the price movement. This downward move will find support, which prevents the security from moving lower. Upon finding support, the security will rally to a new high, which forms the securitys resistance point. The next stage of this pattern is another sell-off that takes the security down to the previous low. These two support tests form the two bottoms in the chart pattern. But again, the security finds support and heads back up. The pattern is confirmed when the price moves above the resistance the security faced on the prior move up.
2.5) ENGULFING PATTERN: This is the most useful candlestick chart pattern. The pattern is highly trad-able because the price action indicates a strong reversal since the prior candle has already been completely reversed. The trader can participate in the start of a potential trend while implementing a stop. An engulfing pattern offers an excellent trading opportunity because it can be easily spotted and the price action indicates a strong and immediate change in direction. In a downtrend an up candle real body will completely engulf the prior down candle real body (bullish engulfing). In an uptrend a down candle real body will completely engulf the prior up candle real body (bearish engulfing).
2.6) HANGING MAN: A bearish candlestick pattern that forms at the end of an uptrend. It is created when there is a significant sell-off near the market open, but buyers are able to push this stock back up so that it closes at or near the opening price. Generally the large sell-off is seen as an early indication that the bulls (buyers) are losing control and demand for the asset is waning. This formation does not mean that the bulls have definitively lost control, but it may be an early sign that the momentum is decreasing and the direction of the asset may be getting ready to change. The reliability of this signal is drastically improved when the price of the asset decreases the day after the signal. Hanging man formations can be more easily identified in intraday charts than daily charts and are a very popular formation used by day traders.
2.7) HAMMER: A price pattern in candlestick charting that occurs when a security trades significantly lower than its opening, but rallies later in the day to close either above or close to its opening price. This pattern forms a hammer-shaped candlestick. A hammer occurs after a security has been declining, possibly suggesting the market is attempting to determine a bottom. The signal does not mean bullish investors have taken full control of a security, it simply indicates that the bulls are strengthening.