How To Read A Technical Chart

by | Jun 17, 2024

How To Read A Technical Chart

Hey everybody!

Phoenix here, you probably recognize me as Nate’s trade analyst… Since I am on the front lines hearing from our students, I noticed a lot of questions about the basics and getting started from our members.

So once a week I am going to provide you with some Trading 101 resources right here in Nate’s newsletter.

Let’s get started!

Understanding how to read technical trading charts is crucial for anyone interested in stock and options trading.

And one of the most common chart types used in options trading is the candlestick chart. So today, I want to take a few minutes to explain how to interpret these charts, teach you about candlesticks and what they mean, and give you a general overview of a technical chart.

So, what are Candlestick Charts?

Well, to start, they look like this:

A screenshot of a computer screen

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Candlestick charts are a visual representation of price movements in financial markets over a specific period.

Each red and green box you see above is what we call a “candlestick”.

Each candlestick provides four key pieces of information: the opening price, the closing price, the highest price, and the lowest price during the period.

The main body of the candlestick shows the range between the opening and closing prices, while the lines or “wicks” extending from the body (both up and down) represent the highest and lowest prices in that time period.

Red vs Green Candlesticks

Candlesticks are typically colored red or green (or sometimes black and white), each color conveying important information about price movement:

Green Candlesticks indicate that the closing price was higher than the opening price during the trading period. This is considered a bullish sign as it suggests that buyers were in control for that period, pushing prices up.

Here’s a great example of a green:

 

Red Candlesticks indicate that the closing price was lower than the opening price. This is a bearish indicator, suggesting that sellers dominated the session and drove prices down.

Here’s a great example of a red:

 

How To Read a Candlestick Chart

  1. First, we must Identify the time frame.
    Candlestick charts can represent various timeframes, from one minute to one week to a month, etc.
    So it’s important to know the timeframe each candlestick represents to understand the trading activity within that period.

 

  1. Second, analyze the candlestick patterns.
    Individual candlesticks can form patterns that traders interpret as signs of potential future movements. For instance, a series of green candlesticks with increasing body sizes could indicate a strong bullish trend:

A green rectangles on a black background

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Meanwhile, a series of green candle sticks could indicate a bearish trend:

A red rectangles on a black background

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  1. Third, we need to look for trends.

    Besides individual candlesticks, the overall arrangement and sequence can suggest broader market trends.

    Ascending green candlesticks might show a bullish trend while descending red candlesticks could indicate a bearish phase.

    In the above images, we can first see a bullish trend in the green candlesticks and a bearish trend in the reds.

 

  1. Fourth, we need to look at the wicks

    The wicks above and below the candlesticks provide clues about trading volatility.

    Long wicks suggest that the price moved significantly during the trading period but then retreated, indicating resistance (upper wick) or support (lower wick).

  2. Lastly, we need to consider the volume.

    By combining candlestick patterns with trading volume, we can see a clearer picture of the strength behind price moves.

    For example, a green candlestick with high volume might suggest strong buyer commitment, reinforcing the bullish signal.

    Here’s an example of our chart with the volume bars at the bottom:

A screenshot of a computer screen

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If You’re New to This Or Looking For A Refresher

Whether you’re brand new to reading Candlestick charts or a seasoned trader looking for a quick refresher, here’s a handful of tips:

  1. Practice with Historical Data. Use historical chart data to identify patterns and see how they played out. This practice can build your intuition and confidence in reading charts.
  2. Use Additional Indicators. Don’t rely solely on candlesticks. Use other technical indicators like moving averages, RSI (Relative Strength Index), and MACD (Moving Average Convergence Divergence) to confirm trends or signals suggested by candlestick patterns.
  3. Stay Updated… Market conditions can change rapidly. So we need to stay informed about broader market trends and news that could impact price movements.
  1. Be Patient and Objective and DO NOT INVEST EMOTIONALLY. Avoid making trading decisions based solely on a single candlestick or a short pattern. Look for confirmation, maintain an objective viewpoint to mitigate risks, and don’t get attached to a winning or losing position.

Knowing how to read a candlestick chart is something I recommend every investor knows how to do.

By understanding how to read candlestick charts, traders can make more informed decisions, and understand momentum and patterns, which can lead to better outcomes in their trading strategies.

Always remember that while technical analysis can provide insights, it’s not always 100%. A series of green candlesticks does not guarantee or ensure that the stock will keep going up. Likewise, a series of red candlesticks doesn’t mean a stock will fall forever… Eventually markets change and revert.

What we can do especially well by reading candlestick charts is understand the trends, momentum, and direction that a position is moving.

I hope this helps!

— Phoenix Van Zutphen

 

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