Most of us, when started gazing at Forex financial charts were very comfortable with the most basic chart, the line chart. Financial Line chart connects points of value, mostly through time and gives us the general price. This is the kind of Forex chart that you mostly find on the unprofessional media.
However, price values are very dynamic data that within any amount of time can further be drilled down to reveal more fluctuations.
It wouldn’t be practical to look only at one point (the Close price for the unit of time, e.g. Day) while in that unit of time there could be significant fluctuations that might have taken the price much higher and/or much lower, and had we noticed it on the chart, we would see completely different conclusions as for the specific financial instrument.
One solution might be to drill down and instead of connecting as example the daily close prices, we might put all the hourly close points and connect them together, so the line chart includes more fluctuations and shows us much more of the true range for the price action through that period of time.
This solution is not recommended, because within each smaller amounts of time (e.g. hourly mentioned), the close price might again miss out important highs and lows created within that hour. As we took only the close of each hour and connected all of them by a line, we got much more “noisy” line which still won’t cover, necessarily, all the important values recorded within that amount of time.
Any further attempt to drill down more and connect the close of minutes (and even bellow, i.e. seconds) would result in a very noisy line chartthat shows too much information and prevents us from seeing the important big picture – had we desired to analyze the price action. You can’t see the forest for the trees.
In order to solve this, the Forex financial community uses two other forms of charts extensively, the Bar chart and the Japanese Candlestick chart.
Both of them were invented to represent the price action much more accurately giving the viewer a relatively good perspective as for the bigger picture before making any decisions.
Basically both the Bar charts and the Japanese Candlestick bar show the same pure data, but the Japanese candle stick chart,being more visual, reveals sometimes price action elements that might catch a forex professional eye.
The Japanese Candlestick chart was invented by the Japanese rice traders in the 18th century. The Bar chart is more modern, its origin was from the West.
Instead of taking only one point (mostly the close price) as data for any timeframe used (e.g. a day), we should take 4 major points:
- The Open price
- The High price.
- The Low price
- The Close price
If the timeframe for the chart is the Daily timeframe, then we should gather for each day all four prices in order to create one Bar (or a Candlestick).
Bars in a bar chart look like this:
The left bracket is printed at the price value reached when the bar was opened (i.e. the open price of the day if it is a daily bar). The price then goes up to the highest valuefor that time unit, or down to the lowest value. The bar formation won’t tell which side,the high or the low, was hit first. The right bracket is printed at the value the bar closed at. For a Bar in the making, the last price is printed and changes dynamically as the close value, till the end of the current timeframe where the bar gets its final shape (close value) and a new bar start to emerge.
Candlesticks look like this:
The principle in Candlesticks is very much the same, but the notation is quite different, including one extra derived thing: If the open price is lower than the close price (prices went higher thru that period of time) the candlestick is painted by a color that represents a bullish tendency (e.g. green). If the open price is higher than the close price (prices went lower thru that period of time) the candlestick is painted by a color that represents a bearish tendency (e.g. red).
Instead of left and right brackets to indicate the open and close prices respectively, the price range within the open and close prices is the “body”, the wide area of the painted candlestick, while the higher prices till the high of that period of time and the low of that period of time are represented by “Shadows”, Wicks, and also the term “Tail” might be used as well. Again, like in Bars, for a candlestick in the making, the last price quoted is considered to be the close price so far, and moves dynamically till the end of the timeframe when the specific candlestick finally gets its final formation, and a new one emerges.
Chart1, the Daily Forex line chart of AUD/USD shows the same period of time as Daily Bars, and as Daily Candlesticks. It is obvious that we see much more important information, without useless information that wouldn’t contribute anything. To see an example of important information that is missing on the line chart but not on the Bar and Candlestick charts, please refer to the left hand side of the chart. On the line chart (Chart 1) we observe a very strong move up with bullish momentum whichdoesn’t break any important low on the way up. On the same period of time, the bar and candlestick charts (Charts 4 and 5) reveal that the price made some important false breaks down before going higher, a signal that would have attracted many traders to join the trend up. The line chart lacks this important information.
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