Reading charts — a beginner’s guide
Whether you're dealing with CFD on commodities, indices, or currencies, learning to read and analyse charts is crucial for your success. A chart displays all the information you need about an asset's past performance, current trend, and potential future direction. This knowledge will empower you to identify trading opportunities and potential profits. In this article, we'll explore what constitutes a chart and delve into the basics of technical analysis, which will help you forecast future price movements.
What is a trading chart?
The main purpose of a trading chart is to display the current price of the trading instrument and to show how it has changed over time. It is relevant for any assets—gold, stock, currency’s exchange rate and more.
Any chart has two components:
- The time axis: It is a horizontal line at the bottom of the chart. Each data point corresponds to a specific time interval.
- The price axis: It is a vertical axis on the right-hand side of the chart. It represents the price of the financial instrument and displays numerical values.
To make this article more handy, you can open a demo account and try your new knowledge right on the chart.
What is a candlestick chart?
The most common chart type is a candlestick chart. It is also the type of chart that we use in our ActuallyTrader platform by default.
The picture below is a typical candlestick chart you'd encounter on ActuallyTrader. It employs a candlestick to visually represent price movements during a specific trading period. The candlestick's body indicates the opening and closing prices, with different colours signifying bullish (upward) and bearish (downward) price movements. The lines above and below the candlestick's body are known as wicks or shadows, depicting the high and low prices during that period.
To read this chart effectively, you need to immerse yourself in the world of technical analysis.
What is technical analysis?
Technical analysis is one of the most widely used methods for evaluating the performance of a trading instrument. By studying patterns and trends of the price, technical analysis helps predict its future movements and identify a setup for a profitable trade. However, any trader should understand that while charts make trading more convenient, they cannot guarantee results. Trading CFD is risky itself, and you may lose your investment.
Technical analysis is a vast subject, covering numerous topics with many analytical methods, tools, and techniques. In this article, we primarily focus on three most basic concepts:
- Trends
- Support and resistance levels
- Candlestick patterns
How to identify trends?
Trends are important because they help you understand the dominant sentiment within the marketplace and identify the general direction of price movements. There are three types of trends:
- An uptrend or bullish trend: It occurs when the price moves up.
- A downtrend or bearish trend: You can see it when the price moves down.
- A sideways trend: It arises when the price fluctuates within a specific range.
To identify an uptrend, you can connect two points in the market where one point is higher than the other, known as a swing high. Conversely, to spot a downtrend, you connect two points where one point is lower than the other, referred to as a swing low.
In the example below, bullish trends are denoted in blue, while bearish trends are highlighted in white.
You can find trends on all timeframes: minutes, hours, and days. Once you identify a trend, you can search for relevant trading setups. In a bullish trend, traders usually look for buying opportunities, whereas in a bearish trend, they seek selling opportunities.
How to find support and resistance levels?
Prices don't move in a linear fashion. Trends often pause near specific obstacles, called support and resistance levels.
- A support level: It is a price level at which a trading instrument tends to stop falling and may even rebound.
- A resistance level: It is a price level at which a trading instrument tends to stop rising and may even pull back.
Identifying support and resistance levels will help you identify potential entry and exit points. Then, you can set them on the chart using stop-loss and take-profit orders. In this case, your position will be automatically opened or closed on the exact price level.
Static or horizontal support and resistance levels are found near round numbers or where a lot of buying and selling activities took place in the past. However, support and resistance levels can also be dynamic and change over time as market conditions evolve. For example, a bullish trendline you saw on the chart above can act as a kind of dynamic support, while a bearish trendline acts as a resistance. Notice that once the trendline gets broken, the opposite trend usually follows.
How to use candlestick patterns?
Individual candlesticks on the chart contain a wealth of useful information and can also serve as indicators of future price changes. There are numerous candlestick patterns, each with interpretation and significance in technical analysis. While it may take some time to learn all of them, as a beginner, you can focus on just a select few. Below there are 3 most common candlestick patterns:
- Doji: A Doji occurs when the opening and closing prices are virtually equal, resulting in a small or nonexistent body with long wicks. It suggests indecision in the market and potential reversal or continuation depending on its placement within the trend.
- Morning Star: This pattern contains three candlesticks and indicates potential reversals. The morning star appears at the bottom of a downtrend and consists of a long bearish candle, followed by a small-bodied candle, such as doji, and then a bullish candle.
- Engulfing Pattern: An engulfing pattern consists of two candlesticks where the second candle's body completely engulfs the first candle's body. A bullish engulfing pattern can signal that the price will continue to move higher.
Below, you can see real examples of these candlestick patterns. Notice that all three patterns performed according to the textbook. A Doji candle after a strong bullish trend signalled indecision, so an uptrend paused and then reversed. The Morning Star pattern indicated that the preceding bearish trend had exhausted, and the price started to rise again. Similarly, an engulfing candle indicated that the bullish trend had more room to run, and the price continued to rise for a few more days.
Conclusion
Mastering the art of reading and analysing charts is essential for successful trading in the financial markets. As a newbie in the world of trading, it may be challenging for you to make informed decisions without studying past performance, current trends, patterns and other indicators.
Technical analysis helps you predict future price movements and improve trading performance. However, technical analysis is an immensely broad subject. We recommend approaching it gradually and thoughtfully.
- Start using simple things, such as trends, candlestick patterns and support and resistance levels.
- Then, move on to more complex ones, such as price action, price patterns, indicators, volume analysis and market sentiment.