Charting A Course (1)

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We have used the term, "chartist" in past blogs as another term for technical analyst.  There are as many types of charts as there are chartists.  The form of chart used is a personal decision which, I suspect, is dictated by the type of information the technical analyst believes is important and predictive.  The chartist wants the information presented in a fashion with which he or she  feels most comfortable.  There are two forms of chart used by many in the technical community: the bar chart and the point and figure chart.  First, we will learn about the bar chart ("BC").

The BC gives the analyst a picture of price movement over time.  The individual making this type of chart notes the price points along the vertical axis and the discrete time periods along the horizontal axis.  The vertical line or bar within the graph shows the price movement for the selected time - a day, a week, a month or any other time period the chartist wants to work with.  For our example, we'll use a daily bar.  The top of the bar is the highest price of the stock that day.  The bottom of the bar, conversely, is the lowest price of that day.  The closing price within that price spread is noted with a horizontal hash or tick line across the vertical bar.  Creating a BC of daily prices takes time and patience because a few days of bars will not reveal much more than daily randomness, i.e., market noise, so to speak.

As we learned in the last blog, volume plays an important role in providing a complete picture.  Many BC graphs will also indicate the volume for the selected time period.  In our example, the daily volume (again as a vertical line) would be drawn at the bottom of the chart below the price bar for each day.  This is really a graph within a graph since the left side of the graph below the price axis must also show volume numbers.  If a stock trades several thousand shares a day, the volume points can be set in thousands.  If it trades only a few hundred shares daily, then the volume axis points can be set in hundreds.  The goal in our example is to show the ebb and flow of both the stock's price movement and trading volume for each day.

I must apologize for the rather tortured two paragraphs above.  It is very difficult to describe a graph in words.  This link to the website EHow.com  will provide a short video about the BC, the most popular form of graphing.

The second most popular graph is the point and figure chart ("PF").  The main difference between the BC and the PF chart forms is the fact that time is not an element in PF charts.  The focus is solely on price movement, up or down.  A sheet of graph paper is a page of boxes.  The PF chartist designates a dollar value for each square on the graph: $1, $5, or any dollar amount the he or she decides to use.  The vertical axis on a PF chart lists prices.  The horizontal axis on a PF chart does not have a value measure.  So long as the price of a stock is advancing, the rise in price is indicated by X's (each X representing the designated dollar box value) added in the same column.  When the price goes into decline, the chartist moves to the next column to the right and notes the decline(s) with one or more O's starting at the first declining price point (again based on the dollar value of each box).  Additional O's are added in that same column, so long as the price continues to decline.  

Let me provide an example.  If the dollar value of each box is $3 and the price has risen $15, then the chartist marks 5 boxes in a column matched to the prices shown on the vertical axis of the graph.  Each time the price goes up another $3, another X is added to the same column, keeping pace with the prices noted on the left axis.  If the chartist has decided that a reversal will not be graphed unless it exceeds $6, then the X's continue to be added (at $3 per X) until the price reverses by $6 or more.  At that point, the chartist starts marking O's in the next column to the right (starting at the first declining price level) and continues to show price declines in that column (in $3 increments) until a reversal to the upside of $6 or more occurs.

Time does not play a role in the PF chart.  Price movement is the only thing that matters. The X's or O's continue to be added to the same column until the price reverses.  In order to avoid small  daily fluctuations, which would result in an unwieldy chart, the chartist may decide not to show a reversal unless the price has either risen or declined by a set amount, such as $6 or more as in my example above.  This number would be picked by the analyst based on the stock's average daily volatility.  I am not a chartist, but it seems to me that a second graph sheet supplementing the PF chart showing trading volume would be helpful.  I have no idea how such a chart would be set up, but since volume is considered such an important factor in technical analysis, you would think a PF chartist would want to keep track of it.

Again, I apologize for this rather dense text.  A clearer presentation, with an example, can be seen with this link to the website Stockcharts.com.

We will continue exploring charts in the next blog.

Comments are always welcome.