What are trading charts? Part 1February 20, 2021 2021-04-18 20:40
What are trading charts? Part 1
Trading charts are used to plot the price of a market over time. This can be any market where the price changes, could be financial or non-financial markets.
As a trader, it’s important that you understand how charts work and the different types there are. Even if you don’t use technical analysis to base your trading decisions, it is still definitely worth being able to read them.
This article is all about trading charts, how they work, why they’re important and most importantly, how you can use them.
- How charts work
- Why they’re important
- How to read them
- How to trade using the charts
- When charts should be used
- What to consider when using charts for trading
How do trading charts work?
Trading charts work by allowing you to analyse the changes in price of any asset over time. They’re a visual tool that makes it easier to find patterns within the markets.
Trading charts take data from the market and plug it into a chart on a computer. In the past this might have been done by traders by pen and paper, but now with new technology, it’s all done online. These charts are found on trading platforms that your broker provides or independent ones like Metatrader 4.
Charting platforms receive a data feed from the market, and normally this is in real time however depending on the platform you can get a delay on this.
The delay is normally 10-15 minutes but this delay makes day trading almost impossible because you don’t know where the price is. The delayed feeds are best for longer term trading because a 10 minute delay won’t have too much impact on your trade.
Trading charts explained
We’ve already mentioned what trading charts are, they’re the price of an asset plotted against time. But thanks to the amount of data we can now generate, we can drill down into time frames of only a minute.
This means that you can apply your trading strategy on several different timeframes and use these to your advantage.
Technical analysts will use trading charts extensively to decide their trade direction and entry. However, it’s also commonplace for other analysts to use basic versions of trading charts to quickly be able to picture the direction of the market.
Trading charts give you that information immediately, just by looking at them (assuming you know what you’re looking for).
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Why are trading charts important?
Trading charts are the basis of technical analysis. Without them you wouldn’t be able to analyse the markets that way. You would have nothing to analyse.
Therefore, trading charts are vital for technical analysts and traders.
They’re also important because they’re relatively easy to understand and give anyone a good idea about a market’s behaviour. For this reason, financial trading has seen huge growth in participation from relative beginners. That and the growth of the internet.
It’s often where beginners start when they start trading, because they don’t need to fully understand the economics and reasons why markets move.
Not only do trading charts provide a gateway to the markets for novice traders, but by studying them, you can also see the psychology behind a market. You can see where traders got excited, nervous, and more.
It’s also worth remembering the tenets of Dow theory. In technical analysis, the price discounts everything. Charts are a visual representation of this.
How to read trading charts
If you’ve never seen a trading chart before, it can be quite daunting. Funny shapes that you might not understand. But actually, once you’ve had a quick lesson, it is fairly self explanatory.
There are several different types of charts that help present the price, some more complicated than others. We cover those types in more detail in the second part of this lesson ‘What are trading charts? Part 2’.
Learning how to read charts is like anything, it comes with practice. The more you use them to analyse the markets, the better you will become at reading them.
At the very basic level, there is an x-axis and a y-axis. Traditionally, you will find price on the y-axis and time on the x-axis. The price is then plotted according to those variables.
How to use live trading charts
Live trading charts are used to analyse the markets and come up with a strategy to trade. We’ve alluded to it already but there is a difference between using live data and delayed data, we’d always recommend using live data where possible. Even if you’re a long term trader, being able to see the live price ensures that you’re not blinded by any erratic moves.
If for example there is a ten minute delay, you might think you’re buying at one price, only for it to be considerably higher than you expected. A price you perhaps would not have considered buying at.
As a quick example, if you want to buy a stock at $100 and you see that the price has reached that level, you hit buy. But actually find you’ve bought at $120, because the market increased during the period from where you saw the price to where it actually is now. Meaning you pay 20% over what you expected, not ideal.
How to trade using charts
You can use thousands of different indicators to help you use a chart but the main reason any trader will use them are for the following reasons:
- Direction — If you can’t pick the direction of the market, then you will find your account lower and lower each time. Charts are a great way to help determine the direction of the market. Is the price likely to move up or down?
- Entry — Once you have determined the direction, you then need to figure out where is the best place to enter. This will be used in combination with the stop loss and take profit levels.
- Target — Once you’ve determined entry and direction, you need to understand how far the market will go and how far you’re willing to hold the trade. You don’t want to buy a market that will only go up for a very short period if you’re a long term trader.
- Stop-loss — This is an essential risk management tool and allows you to exit a trade if your analysis is disproved. The combination of the entry, target and stop loss will help you determine your risk to reward ratio.
- Management — You can use charts to manage your open positions. This might be bringing the stop loss closer or deciding to let your profits run further, charts are used to make these decisions.
When should trading charts be used?
This will depend on the type of trader you are. If you use technical analysis, then trading charts should be used when analysing and coming up with your trading decisions.
If you’re a fundamental trader, then using trading charts are still recommended but more as a secondary item to check or confirm.
The asset class and timeframe doesn’t matter, as long as the price moves, then you can use charts to analyse it.
No matter how you analyse the markets, you should learn how to read a chart.
Best charts for trading
Deciding the best charts to use for trading is a bit like asking what is the best colour. There isn’t a right answer, it comes down to the person using them.
The most common types of trading charts are:
- Line charts
- Candlestick charts
- Bar charts
We’ll cover these and more types of charts in more detail in our next lesson. But the above charts are the most common, mainly because they’re the easiest to use.
Lots of respected analysis websites do their analysis using candlestick charts but this is their preference. Candlesticks are visually nice and easy to read.
There is also no best chart for a different asset. It again comes down to your preference. Don’t rule any chart type out, instead, test them and see for yourself.
Don’t get too swayed by everyone else, there are lots of opinions on this and no correct answer. Find what you like and stick to it.
What to consider when trading with charts
There are a few things you should consider when using charts:
- Data – What is the data stream, where’s it from, is it accurate, and is it live or delayed?
- Chart type – Does the chart type correspond with the trading strategy you’re using. Do you only use chart type 1 for a certain asset for example.
- Time frame – Does the chart type suit the timeframe you’re using to analyse the market.
- Education – Are you fully up to speed with everything you should know about the trading chart you’re using? There’s nothing you don’t understand?
Ensure that you’re comfortable with these points and then get testing, analysing and trading with charts.