Stock market analysts use charts to plot the price movements of a stock over specific time frames. It's a graphical method of showing where stock prices have been in the past.
A chart has an x-axis (horizontal) and a y-axis (vertical). Typically, the x-axis represents time; the y-axis represents price. By plotting a stock's price over a period of time, we end up with a "pictorial representation of any stock's trading history," explained Richard Schabacker, the acknowledged father of technical analysis.
A stock chart can give us a complete picture of a stock's price history over a period of an hour, day, week, month or many years.
A chart can also depict the history of the volume of trading in a stock. That is, a chart can illustrate the number of shares that change hands over a certain time period.
Technical analysts rely on a wide variety of charts in their work.
"Line charts" are so named because of the line which moves across the chart connecting the closing prices of a specific stock or market over a given period of time. This type of chart is particularly useful for providing a clear visual illustration of the trend of a stock's price or a market's movement.
"Bar charts" provide a visual representation of the price activity in a stock over a given period of time. On a daily bar chart, for example, a vertical bar connects the highest price reached by the stock on a given day and the lowest. Small lines on either side of the vertical bar serve to mark the opening and closing prices. The opening price is marked by a small tick to the left of the bar, the closing price is shown by a similar tick to the right of the bar. Although daily bar charts are best known, bar charts can be created for any time period - weekly and monthly, for example. Many investors work with bar charts created over a matter of minutes during a day's trading.
"Candlestick charting" is also referred to as "Japanese charting" because of its popularity in that country. As the name implies, a candlestick chart looks like a collection of candles with wicks. The chart contains the identical information of a bar chart (opening and closing prices, highs and lows) but it displays it differently and, many would argue, more effectively. The candle portion of the chart visually represents the difference between the opening and closing price for the period charted. If the candle's body is black, that means that the closing price was lower than the opening price. If the candle's body is white, then the closing price was higher than the opening price. The "wicks" at either end of the candle mark the high and low prices reached by the stock during the period. These wicks are also referred to as "hairs" or "shadows."
A chart is the technical analyst's tool.
By charting the price movements of a stock over a period of time, a technical analyst has a convenient and easy-to-read source of information. The technical analyst can see the complete record of a stock's trading history at a glance.
As Schabacker wrote back in the 1930s, because charts make "the groundwork of fundamental co-ordination of the facts so easy, so simple, so readily grasped, it leads naturally into a more detailed study of the phenomena which it pictorializes; the actual results of the trading history presented, the patterns, the rules, the characteristics of behaviour. In short, it leads to a new science, the science of technical chart action."
Technical analysis is based on the idea that to know where stock prices are going, you must know where they have been. Therefore, charts are a fundamental element of technical analysis. Technical market analysis is based on the technical action of the market itself. According to technical analysis, the market is - at its most basic - groups of buyers pitted against groups of sellers.
Put buyers and sellers together and the law of supply and demand is not far behind. According to that law, when demand exceeds supply, prices rise. When supply outruns demand, prices fall.
Knowing if there are more sellers than buyers in a market, for example, will mean knowing that supply exceeds demand and, as a result, prices are declining.
Price charts - by detailing the history of price movements of a stock - are the key tools of the technical analyst. Charts tell the story of whether the market is moving up or down, helping investors to find the stocks they wish to buy and determine which stocks they want to sell.
Experts will tell you that charts do not predict. According to technical analysts, charts are valuable in determining the probabilities of success for the decision to buy, sell or hold. The key to successful technical analysis is figuring out how to analyse the information the charts provide and, in turn, forecast future price movements.
The "trend" is what technical analysts are looking for in their charts. Chart analysis is based on the theory that prices tend to move in trends, and that past price behaviour can give clues to the future direction of the trend.
The purpose of chart analysis is to identify and evaluate price trends, with the objective of profiting from the future movement of prices. "A chartist's asset lies not so much in his being able to forecast how high or how low a market will go, or when it will get there, as in being able to identify the direction of a trend and to call the turn of a trend when it comes."
While technical analysis focuses on the action of the market itself, the other major form of market analysis - fundamental analysis - concentrates on studying the potential of a stock by focussing on the fundamentals of the company and the economic environment in which it is operating. A fundamental analyst will look at the business of the company, its earnings and dividends - all the relevant factors that determine the success or failure of the business. Like technical analysis, the goal of fundamental analysis is the determination of where stock prices are headed. According to Murphy, "the fundamentalist studies the cause of market movement, while the technician studies the effect."
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