Types of Chart Patterns in the Stock Market

In financial analysis, charting is a significant tool that provides an informative visual story from historical data. Traders and investors primarily use this practice to untangle patterns and trends to gain valuable insights into the market. Charts are more than just a history record – they depict market behaviour and have evolved from hand-drawn sketches to computerised accuracy. In addition to prices, charts frequently include volume figures, giving a complete picture of the market.

In this segment, let us explore charts and their various types, which are essential in technical analysis. Charts serve as visual depictions of price data for securities across time, offering a comprehensive overview of market dynamics. They provide a means for technical analysts to readily identify market volatility and make informed decisions regarding entry and exit points, as well as strategically placing stops to manage risk effectively.

Why are Charts Important in the Stock Market?

Think of charts as a money map for stocks. They show the highs, lows, and trends – like a financial snapshot. People often call them the 'footprint of money' because they quickly tell the story of a stock's history. This helps investors make smart decisions.

Let's explore why charts matter and how they guide investment choices.

• Objective Analysis - Charts provide a visual history of a stock's prices, reducing the impact of emotions on decision-making. This helps traders and investors make choices based on factual evidence and data, minimising the role of emotions in their strategies.
• Confidence in Decision-Making - Charts represent a visual representation of market data, fostering confidence in decision-making by guiding choices based on concrete evidence rather than speculation.
• Risk Management - By looking at price changes, charts help assess the risk of different investment options, making risk management more effective.
• Strategy Development - Charting helps create effective trading or investment strategies by providing valuable insights into price patterns and trends. These insights empower individuals to customise their approaches based on current market conditions, increasing their chances of success.

Types of Charts in the Stock Market

Line Charts:

Line charts, the most basic form of financial charts, depict price changes using closing prices, forming a line connecting these points. Intraday fluctuations can also be shown, either by plotting each trade or selecting closing prices at intervals.

• The horizontal axis (X-axis) represents time, while the vertical axis (Y-axis) represents the price. Each data point on the chart represents the closing price at a particular time. The closing prices are connected with a line, visually representing the price trend over time.
• Line charts are effective for identifying trends in the market. An upward-sloping line indicates an uptrend, while a downward-sloping line suggests a downtrend.
• They are often used for quick and basic analysis, suitable for traders who prefer a straightforward representation of price movements.

In the example above, you can see a line chart representing the closing prices of a stock over a specific time period. The upward-sloping line indicates an overall uptrend in the stock's price. Traders may use this information to make decisions based on the perceived trend direction.

Bar Charts:

The next fundamental tool in technical analysis is Bar Charts, which visually represent price movements in financial markets. These charts display the open, high, low, and close prices for a specific time period, providing valuable information for traders and analysts.

• Each bar in a bar chart provides more information than a line chart.
• Bar charts are commonly referred to as OHLC charts (open-high-low-close charts). These distinguish themselves from traditional bar charts used for different data types.
• Coloured OHLC Bars and HLC Bars display price bars in either green or red, determined by the close price in comparison to the previous close. If the close is higher than the previous close, the bar appears green; if it is lower, it appears red. 
• This type of chart showcases both the price and volume (number of shares traded) of a stock across a time period, typically measured in days, weeks, or months. 
• For instance, a daily bar chart displays the highest, lowest, and closing prices each day, along with the daily traded share volume. 
• Similarly, a weekly bar chart depicts the highest and lowest prices for the entire week alongside the total weekly trading volume.
• The following example is a visualisation of the company’s stock over a period of time:

The above visualisation shows the characteristics of a bar chart. The peak of the bar indicates the highest trading price observed during that period, and the base of the bar signifies the lowest trading price. A brief horizontal line on the left denotes the opening price for that timeframe, while a corresponding line on the right signifies the closing price. 

There are essentially four combinations of bar charts:

• Up Day: An "up bar" or "up day" occurs when both the high and low of the current bar are higher than those of the previous bar.
• Down Day: A "down bar" or "down day" is characterised by the high and low of the current bar being lower than those of the previous bar.
• Inside Day: An "inside day" is identified when the high of the current bar is lower than the high of the previous bar and the low of the current bar is higher than the low of the previous bar.
• Outside Day: An "outside day" occurs when the high of the current bar surpasses that of the previous bar while the low of the current bar falls below the low of the previous bar.

A column chart is similar to a bar chart, except In a column chart, the bars are vertically oriented, rising from the horizontal axis. Each column represents a category or time period, and the height of the column corresponds to the data value.

Area Chart:

Unlike line charts that only connect closing prices with lines, area charts fill the area between the line and the horizontal axis, providing a shaded visual representation of price action. The colour-coded filled area helps traders see the overall direction, and it's commonly used for analysing broader trends in longer timeframes.

• Start Point: The chart begins at a specific starting point, usually the left side of the chart.
• Closing Prices: The area between the closing prices and the horizontal axis is shaded, creating a visual representation of the price movements.
• Colour Coding: Different colours may be used to distinguish between rising and falling price movements. For example, the area above the line might be shaded in green for upward movements and red for downward movements.

As we can see in the above example, green has been used for advance, while red for r decline.

Candlestick Charts:

Let's transition to another essential aspect of charting - the candlestick chart. Candlestick charts serve as a method to present information about the price dynamics of an asset. Among the key elements of technical analysis, these charts are highly favoured by traders for their ability to swiftly convey price details through just a few bars.

These charts incorporate three primary components:

• The body: Represents the open-to-close range of prices.
• The wick (or shadow): Indicates the intra-day high and low points.
• The colour: Reflects the direction of market movement—green (or white) denotes a price increase, while red (or black) signifies a price decrease.

As time progresses, individual candlesticks form patterns that traders leverage to identify significant support and resistance levels. The multitude of candlestick patterns available offer insights into market dynamics—some reveal the balance between buying and selling pressures, while others identify continuation patterns or instances of market indecision.

Each candle's thin part shows the day's trading range and the wider part (the body) represents the space between the opening and closing prices. A positive or open candle means the stock closed at the top of the body, similar to a bar chart where the 'Tick' on the right side denotes the closing price. Conversely, darker candles indicate negativity, suggesting the stock opened higher for the day but closed at a lower price.

A candlestick can have either a hollow or solid body.

• Hollow: The term "hollow" refers to a candlestick body that is not filled, signifying that the closing price is higher than the opening price. This type of candlestick is commonly depicted in white or light colours.
• Solid: On the other hand, a "solid" candlestick represents a bearish market sentiment. The body is filled, indicating that the closing price is lower than the opening price. Solid candlesticks are often portrayed in black or dark colours.

Traders and analysts use these patterns to interpret market sentiment and make predictions about potential future price movements. 

Heikin-Ashi Charts:

Heikin-Ashi charts offer a quicker means of forecasting and are considered more user-friendly than candlestick charts.

While Heikin-Ashi charts resemble candlestick charts, their calculation and candle plotting methods differ. Unlike candlestick charts, where each candle is independent, Heikin-Ashi candles are calculated based on the previous candle's information. Let us look at a few important terms in its calculation.

• First Open Price: The open price in a Heikin-Ashi candle is the average of the previous candle's open and close prices.
• Second Close Price: The close price in a Heikin-Ashi candle is the average of the open, close, high, and low prices of the previous candle.
• Third High Price: The high price of a Heikin-Ashi candle is selected from the high, open, and close prices of the previous candle, choosing the highest value.
• Fourth Low Price: The low price of a Heikin-Ashi candle is selected from the high, open, and close prices of the previous candle, choosing the lowest value.

Let us understand this with an example: Assuming the previous day’s candlestick had the following values:

• Open: 1200
• High: 1300
• Low: 1125
• Close: 1250

The calculation method is as follows:

• Calculate the midpoint value (MP) of the current candlestick:
• MP = (Open + Close) / 2 = (1200 + 1250) / 2 = 1225
• Calculate the average price (AP) of the previous candlestick:
  • AP = (Open + High + Low + Close) / 4 = (1000 + 1300 + 1125 + 1250) / 4 = 1225
• Calculate the new Heikin Ashi values for the current candlestick:
• HA Close = (Open + High + Low + Close) / 4 = (1200 + 1250 + 1187.5 + 1225) / 4 = 1215.625
• HA Open = (HA Open of the previous candle + HA Close of the previous candle) / 2 = (1100 + 1150) / 2 = 1125
• HA High = Max(High, MP, HA Open) = Max(1300, 1225, 1125) = 1300
• HA Low = Min(Low, MP, HA Open) = Min(1125, 1225, 1125) = 1125

Therefore, the Heikin Ashi values for the current candlestick are:

• HA Open: 1125
• HA High: 1300
• HA Low: 1125
• HA Close: 1215.625

These values can be plotted on a chart for visual representation, following the Heikin Ashi calculation method.

In the above example, we have a Heikin Ashi chart.It t's effective for identifying trends – green signifies upward price movement (bullish), while red indicates a downward trend (bearish).

Heikin-Ashi charts exhibit a slower pace than candlestick charts, and their signals are delayed due to the interrelation between candles. This delay proves beneficial for trading volatile currency pairs, preventing hasty decisions against market trends.

The inherent delay in Heikin-Ashi charts results in fewer false signals, reducing the likelihood of making erroneous decisions. While the chart is simpler to read due to the absence of numerous patterns seen in candlesticks, some traders opt to rely exclusively on Heikin-Ashi for trading. 

Renko Charts:

Renko charts are a type of financial chart used in technical analysis to represent price movements. Unlike traditional candlestick or bar charts, Renko charts focus solely on price changes, ignoring time and volume.

The following illustration is a Renko chart for the Nifty 50 Index over a period of time.

Let's delve into some key features of a Renko chart.

• Brick Size:

The basic building block of a Renko chart is a "brick," and its size is pre-determined by the user.

The brick size represents the minimum price movement required to add a new brick to the chart.

• Construction of Bricks:

When the price moves beyond the user-defined brick size, a new brick is added.

The direction of the movement (up or down) determines the placement of the new brick.

• Time Axis

Renko charts incorporate a time axis, yet the time scale is variable. The formation of each brick may take varying durations, contingent on the time it takes for the price to move the specified box size.

Time intervals between bricks can vary, and new bricks are only added when the price reaches the specified movement.

• Trend Identification:

An upward trend is represented by a series of ascending bricks, while a downward trend is depicted by descending bricks.

Let's consider a hypothetical scenario to understand the Renko Chart where:

• Brick Size: ₹10
• Opening Price: ₹100

• First Brick (Upward Movement):

Closing Price: ₹110 (₹100 + ₹10)

A brick is formed as the closing price shows an upward movement exceeding the brick size.

• Second Brick (Downward Movement):

Closing Price: ₹100 (₹110 - ₹10)

Another brick is formed as the closing price experiences a downward movement equal to the brick size.

• Third Brick (Upward Movement):

Closing Price: ₹120 (₹100 + ₹10 + ₹10)

Another brick forms due to an upward movement surpassing the brick's size.

This iterative process continues, with each brick representing a ₹10 movement in the specified direction. It's essential to note that actual market data would involve more complexity, and Renko charts are typically used alongside other technical analysis tools for a comprehensive assessment of market trends.

Baseline Charts:

The Baseline chart is a visual representation that illustrates price movements in relation to a user-selected baseline. This type of chart can be highly beneficial for analysing and understanding fluctuations in prices over a specific time period. By setting a baseline, traders and analysts can gain insights into the relative performance and changes in asset prices, aiding in the assessment of market trends and potential trading opportunities.

In charts and graphs, the term "baseline" refers to a starting point or line against which other data is measured. It serves as a reference for understanding the values and trends presented in the chart. The baseline serves three main purposes:

• Directional Signal: It indicates the direction in which you should trade. If the price crosses and closes above the line, it suggests a long trade. Conversely, if the price crosses and closes below the line, it signals a short trade.
• Exit Signal: The baseline signals when to exit a trade. If the price crosses and closes above or below the line in the opposite direction of your trade, it's a signal to exit.
• Optimal Entry Point: It helps determine the best entry point for a trade. Before entering a trade, all indicators should align, and the price must be within the Average True Range zone. If the price moves outside of this zone, it indicates that the price has deviated significantly, and entering the trade at that point may involve overpaying.

Line Break Charts:

Line break charts are a specialised form of financial charts used by traders to analyse price movements. What sets them apart is their exclusive focus on price changes, disregarding time and volume—a characteristic they share with Renko charts. The fundamental principle is straightforward: lines are drawn only when the price surpasses a predetermined threshold, creating a visual representation that emphasises trends and significant price movements.

There are four primary types of lines in line break charts,

• Up Lines: It is formed during an uptrend, indicating positive market direction.
• Down Lines: These are formed during a downtrend, signalling a negative market direction.
• Projected Up Lines: These lines are anticipated during an intraday time frame, indicating a potential up line based on the current price before the actual closing price is set.
• Projected Down Lines: Envisioned during an intraday time frame, these lines indicate a potential down line based on the current price before the actual closing price is established.

The following chart illustrates the representation of a line break chart:

As financial markets evolve, line break charts provide a timeless approach to understanding and navigating market dynamics.

KAGI Charts:

Kagi charts, originating from Japan, represent a distinct approach to visualising price movements in technical analysis. These charts diverge significantly from traditional candlesticks or bar charts, offering a unique portrayal of market trends. 

let's look at some important features:

• Axes: The horizontal axis (X) shows dates, and the vertical axis (Y) represents the value scale.
• Lines: There are two main types of lines: a thicker green line (yang line) and a thin red line (yin line). The yang line suggests more demand than supply, signalling an upward trend. The yin line indicates more supply than demand, pointing to a downward trend.
• Waists and Shoulders: Horizontal lines connecting a falling line to a rising one are called waists. Those connecting a falling line to another rising line are called shoulders.
• Reversals: The line direction only changes when the share price moves more than a set reversal amount. This amount needs to be small enough for reliable shifts but not so large that it misses signals. Traders can set this value in dollars or average true range (ATR) instead of a percentage.
• Colour Changes: Waists and shoulders change colour when surpassed. However, the colour doesn't change with every reversal—only when the price goes beyond the waist or shoulder.
• Quick Analysis: Traders can quickly check a Kagi chart to decide whether to buy, sell, or simply observe the stock based on these features.

Understanding these elements helps traders interpret Kagi charts effectively for making informed decisions in the stock market.

Point and Figure Charts:

Point & Figure charts are composed of columns featuring X's and O's, symbolising streamlined price changes. In this representation, X-Columns indicate upward price movements, while O-Columns signify declines. Each price box represents a specific value that must be reached for the inclusion of an X or an O. Unlike conventional charts, and time is not a factor in Point & Figure (P&F) charting; these charts adapt as prices fluctuate. If there is no change in price, the P&F chart remains unaltered.

Among various P&F charting methods, the 3-box Reversal Method stands out as the most popular. In this classic approach, column reversals undergo additional filtering, requiring a minimum of a 3-box movement to reverse the ongoing column.

This is a classic example of point and figure charts where you can see o’s and x’s.

P&F charts offer a distinctive perspective on price action, providing several advantages. They:

• Filter out inconsequential price shifts and noise.
• Concentrate on significant price changes.
• Eliminate the time dimension from the analytical process.
• Simplify the identification of support/resistance levels.
• Facilitate the automatic delineation of both objective and subjective trend lines.

Bottom Line

In summary, charts play a pivotal role in trading and investment strategies, offering a diverse array of types, each with its unique advantages. From the simplicity of line charts to the detailed insights of candlestick charts and the comprehensive data of bar charts, each type serves a specific purpose in market analysis. Specialised charts like Point and Figure bring distinctive perspectives to the table.

Effectively utilising these chart types empowers traders and investors to make informed decisions, spot trends, and navigate the complexities of financial markets. Whether one is an experienced professional or a beginner, incorporating a variety of charts into their analytical toolkit can significantly enhance their ability to interpret market behaviour and anticipate potential price movements.

Charts are like visual guides that help us understand what's going on in the market. Learning about them and practising with them is important for becoming good at trading. Even as technology changes and markets grow, charts remain a valuable tool for success in the world of finance.