In the last article we saw how the Dow Theory helped us to get a
grip on the market. Even though the Dow Theory was really formed to
forecast the larger economy, its tenets are equally – and probably more
successfully – used in the stock markets. We continue in the series to
look at further at the methods that one can use to study the markets.
As
we defined technical analysis, “it is the study of market action
principally through charts”. We therefore use charts as the means for
depicting the market’s movement through time. Charts are therefore the
medium, through which we can read and hear and understand the language
that the market speaks. Since the market speaks only one language –
that of price – it is obvious that we would be plotting the chart of
stock prices. We have another variable in the market – volume. So most
charts would also carry the plot of the volumes.
Plotting Charts
We will initially
address the different types of charts as related to manual plotting.
However, it may be noted that the advent of the personal computer has
changed the scenario so dramatically that hand plotting of charts is
now more the exception rather than the case. Still, there is a lot to
be said for hand plotting of charts. There is nothing else which can
give one a greater “feel” of the market than the manual plotting of
charts. As one looks up the data for the day and lays it down on paper,
one can actually see the patterns evolve and one can get a good grip on
how the trend is shaping up. Further, the chore of doing this day in
and day out (as well as on a weekly and monthly basis) brings in a
certain element of discipline, which, as we all know, an essential
element of success in any sphere of work.
But that is more an
ideal situation rather than the rule. The software makes chart plotting
and changing the chart type a zip. One therefore needs to be practical
and address the modern chartist. The greatest advantage of software
charting is that it eliminates the chore of hand plotting thereby
saving up the time for analysis.
Every exchange-traded instrument would contain the following data : Open, High, Low and Close.
Charts
are plotted on a daily basis using a Price vs. Time scale. The Price
goes on the Y-axis while the Time goes on the X-axis.
One can
also plot the chart on a weekly or monthly or yearly basis. In such
cases, the data points would be the Open, High, Low or Close for the
week, month or the year respectively.
Usually, the charts are
referred to by the time period of the plot such as Daily chart, Weekly
chart, Monthly chart etc. One can also have an intra day chart such as
the 60 minute or 30 minute chart. The principle remains the same – the
frequencies of the data points that are plotted are what would
differentiate the chart.
Another aspect, which needs to be
addressed, is the Scaling. Normally, we always think of scaling as
being linear or the steps on the Y-axis move up on an arithmetical
ratio. In other words, the chart scale is split between the highest and
lowest values on the scale and each of the divisions move up the exact
same amount at every step. This is the most commonly used scale. It has
one problem. Where the stock has made a very large movement, the chart
would lack detail. For e.g. if one looks at the chart of most of the
InfoTech stocks in our markets, one would find that they have moved
substantially – moving up many times the low prices. In arithmetically
scaled chart of Satyam for example, one would find it difficult to
decipher the moves at the price levels below 100 (on a non split basis).
This
problem was solved by resorting to a percentage based scaling on the
Price axis while maintaining the Time axis the same ( i.e one division
per day/week/month). In these charts, the steps of price rise are
percentages of the ones below it. This way a greater amount of prices
are covered. The following illustration might help clear the picture :
| Arithmetically scaled charts |
Percentage scaled chart |
| Steps rise as 10, 15, 20, 25, 30 |
Steps rise as 10, 20, 40, 80, 100 |
| i.e. 5 points per step |
i.e. each step is 100% of the earlier. |
It
can be seen that in the first type (arithmetic) five steps have carried
the prices from 10 to 25 while in the latter (percentage) case, the
steps have managed to carry the prices from 10 through to 100.
Therefore a larger price action can be covered in the percentage scaled
charts. Pictorially it would look like this :
The
two charts shown above are for SSI for the same time period. The one on
the left is an arithmetically scaled chart while the one on the right
is a percentage scale chart. Note that the left side stock has almost
no details of the lower prices while the same is clearly depicted on
the right side chart. It is because of the difference in scaling.
Normally,
one looks at Arithmetic scaled charts over the short term period (such
as intra day and daily charts) while Percentage scaled charts should be
used while looking at longer term charts (such as the weekly and
monthly charts). Also, all stocks, which have undergone substantial
price movement, should be looked at in the percentage scale.
Many
times, the percentage scaled chart is also called the Log chart. Since
only one of the axis is on a percentage scale, it is also referred to
as the Semi Log chart.
The most popular chart types are :
Line Chart : This is the most
frequently chart type that is used. It is, by default, the chart of the
closing prices only. One plots the closing price from day to day and
joins the prices using a line. Hence the name Line charts. Also known
as the closing chart. |
Bar Chart : This type of chart
uses all the four data points – Open (O) High (H) Low (L) and Close
(C). It is also known as the HiLo bar chart or the OHLC chart. The High
and Low points are plotted and joined by a vertical line. The open is
then placed as a small horizontal line to the left of the bar while the
close is placed as a small horizontal line to the right of the bar. |
Candlestick Chart : The same four
data points are used (OHLC) but in a slightly different manner. The
open and close are plotted and joined together by a vertical box while
the high and low are placed as small extensions above and below the
box. The width of the box is kept uniform. Depending on whether the
open is greater than the close or lesser, the box is suitably colored.
If the close is lower, then the box is colored black while if the close
is higher, the box is colored white. This kind of charting is more
visual as it can tell in a flash where the open and close were in
relation to one another. |
Line Chart
Candlestick chart
OHLC Chart
There
are other forms of charting too but not so popular as these three.
These are among the largest used forms of plotting and studying charts.
The other types are :
Point and Figure, Renko and Three Line Break charts :
These are time independent charts where price plots are made when the
stock moves a certain number of points or a certain percentage move
occurs. |
| Kagi : This is a type of charting where the thickness of the line plotted changes with the crossing of previous highs and lows. |
Equivolume : A particular type of
charting method which seeks to combine volumes and prices into one bar.
The bars are made thin or thick based on the extent of volumes that are
seen on that particular time period. A high volume day will have a
thick bar while a low volume day will have a thin bar. |
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