June 23, 2021 | by sandeep
Line Charts Explained
In the 1700s, Japanese rice traders started using charts. They would plot prices over a period of time on paper to identify patterns that could help them make a profit. This proved to be crucial to the growth of Forex trading.
Generally speaking, the three most popular types of charts used in technical analysis are the Line Chart, Bar Chart and Candlestick Chart. Today we’ll cover the first.
To traders, particularly those who trade short term, reading charts is a skill that is instrumental to their success. Understanding how charts are constructed and their capabilities and weaknesses is similar to learning how to read music; it’s really not that difficult but it takes some time and perseverance.
Let’s have a look at a line chart, which is the easiest chart to understand. To build a line chart you simply plot with an ‘X’ every new price reading and then you join all the points with a line. Voila, you have a line chart that displays the change in price over a period of time.
While you are marking the price, you are also marking every single trade on the line chart. On a minute chart, these price marks will constitute what is called a Tick Chart.
For educational purposes, we have made it look much clearer and simple than it would look like in reality. In real life, a tick chart will look more like the one immediately above. The reason for this is that prices tend to jump up and down in tiny increments all the time, every second of the day.
On a tick chart, the price is very much zoomed in with every tiny move recorded and marked because you’re monitoring the marking down of every single trade. This makes it difficult to read the sentiment of the market or understand which way the market is going. So you can overcome this by separating the chart into sections or bands.
Above we’ve separated this tick chart into one-minute intervals. We’ve drawn a dotted line and we’re now aggregating that trade information into bands of one-minute intervals. So, every time a minute passes, you mark where the price was on the dotted line.
Instead of looking at price movement within that minute interval, focus on where the price was at the end of that one-minute interval. By doing that, you can then get rid of all price movements in between.
So now it looks a little more like the image shown above, which is easier on the eyes. It allows you to zoom out and see a bigger picture. By segmenting time, you get greater clarity.
Some might argue that you’re losing information or that price action in between the one-minute intervals. Do you really need that much information? The chart before this would have been more of a hindrance and it could easily confuse someone as to the direction of the market.
Moving forward, you can make it even easier by removing the lines in between the intervals as shown in the picture above. Keep in mind that the MT4 trading platform has intervals that range from five-minutes to week-long ones. So let’s look at a real line chart on MT4.
Line Charts (MT4)
The chart above shows the daily chart time frame. The closing price at the end of each day is therefore marked on the chart.
The line chart can offer a big advantage to Forex traders. It’s simple, clean and very easy on the eyes.
However, you see traders often overanalyze the market with lots of indicators, signals, etc. Sometimes, the more information you’ve got on the chart, the higher the chance, as a novice trader, that you may be overwhelmed with all the things you see on there. So much so that the novice trader goes into what is called Analysis Paralysis or you analyze far too many things not knowing what to pay more attention to, what to believe or what to ignore. The line chart is the simplest and cleanest chart you can get.
So how do you use a line chart to make trading decisions?
Line charts are best to identify potential reversals. You see where the market has stopped moving, decided to turn around and go the other way.
In this picture, what you want to do as a trader is look at where the high is. The price is going up very strongly as shown by the green arrows. Suddenly, the market decided to stop buying and the price shifted down. Something in the area marked in red caused the market to stop buying.
A technical analyst would then make a note of this price and call it a Resistance. It will then be very interesting to see if the market repeats this behavior at some point in the future. If prices get back up to this level, you can then see if the market will do what it has done in the past or break through the resistance.
Strange as it may seem, the price returns to that area again with lots of buying. And just like magic, when the price gets to the resistance, everybody suddenly stops buying. What’s going on?
By now it’s clear that traders do not want to buy beyond this price. In the picture above, we highlight this area in yellow. It is not an exact price but it is an area. Just because it’s happened twice, however, it doesn’t mean it’s not going to happen again. Maybe at some point in the future, if the market returns to that area, it may well do the same thing as it did these last two times.
See that it’s not exactly the same level but it’s very close and it’s certainly within the area you can call resistance.
Let’s show you another example.
In the picture above, the price is moving up very strongly as shown by the green arrow. The buying then stops abruptly at the price level marked with the blue circle. The market doesn’t only stop buying but actually starts selling and the price starts falling.
Now over to the right, as marked by the second blue circle, the price has once again come to that level and stopped going up.
In a bear market, this concept of the price stopping in a particular area is called Support as shown by the purple circle. If the price revisits this area in the future and the market behaves in a similar way, then you could perhaps trade it in a similar way.
As you can see from the price moving over to the right, the market did behave in a very similar way. You can now clearly see how technical analysts use a line chart to determine where areas of support and resistance are.
Of course, you can’t be sure whether or not the price will repeat itself. You don’t know what’s going to happen in the future. But at least you know where to expect a possible repetition, which could give you a head start when planning your trades.
So spotting support and resistance levels on a line chart is pretty easy to do. For this reason, it helps novice traders who want to learn how to trade. It’s easy because there isn’t a lot of information on there to get confused with.
As for the experienced traders who find themselves in this state of suffering from paralysis by analysis, a line chart really simplifies everything. All you have is the closing price depending on what price interval you choose.
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*Any opinions, news, research, analyses, prices or other information contained here are provided as general market commentary and do not constitute investment advice. FXPRIMUS does not accept liability for any loss or damage, including without limitation to, any loss of proﬁt, which may arise directly or indirectly from the use of or reliance on such information.