In Chapter 2 of Robert D. Edwards, John Magee & W.H.C. Bassetti’s Technical Analysis of Stock Trends, a chart is described as being a graphically represented market asset using mathematics. They are further described as being represented in intervals of months, weeks, days, hours, or minutes by marking the chart with plot points by way of connected lines, “point & figure” or by using “candlesticks”, which we will cover later. The charts are constructed using either arithmetic or logarithmic scales. (This is important because the arithmetic scale is generally seen being used by crypto traders online and on YouTube, but Edwards and Magee tell us that semi-log is better for setting stops. More on that later.)
Charts can portray an asset’s moving average, it’s trading volume, average and most active trading prices. All this data is technical in nature and comes from solid market data. Irrational sentiment and similar soft data may be indirectly represented by price movement, but the price itself is anything but soft data. For more on that go back and read my review of the previous chapter, “Technical Theory“.
Edwards & Magee designed this book for the layman, the retail trader as we are referred to. But some of the data is characteristic as such: raw, dry & difficult to consume. That said, I’ve heard traders online say that we have to study these things methodically in order to recall them properly. that we should endeavor to chronologically study only one aspect or section over the course of a day. That’s why I’ve chosen to review this book over a series of shorter blog posts. Furthermore, after an intense period of study, we need to step away and allow our brains to form the connections needed to recall the right info in a timely and effective way. Scott Barkley of ProAct Traders has said that is called “Reticular Cognition” Check out his post here where he references a site describing how our brain works in this respect.
Charts can carry an amalgamation of data. It’s usually just price and traded volume, but it can have things like moving averages and standard deviation. For the purposes of this book, the authors have included only the simplest charts, free of indicators (apart from volume). Edwards and Magee use bars (bars are very similar to candles which are the leading format in crypto and many corners of the securities market). Bars (and candles for that matter) consist of several elements. The first is it’s color. A green candle indicates the price went up and, conversely, a red candle represents downward price movement. In a green candle where the price has gone up, time moves from the bottom of the candle to the top. We call these points open and close. At the beginning of a time interval, say, on the hour, the price of a cryptocurrency is marked as being open. At the end of that same time interval, the price is again recorded, but this time, as being closed. Throughout the course of that time interval, price may rise above an open or a close. Price might also fall below an open or a close. This is all true for both bullish (green) candles where price is said to have risen, and for bearish (red) candles where price is said to have fallen. Take a look at this simple depiction I’ve created…
You can find more on candlesticks from Wikipedia here: https://en.wikipedia.org/wiki/Candlestick_pattern or Investopedia here: https://www.investopedia.com/terms/c/candlestick.asp
Well then, on to scales. Now Edwards & Magee go into a lot of depth here and I considered paraphrasing and elaborating, but the truth is, if you’re here reading this, you’ll probably want to forgo a discussion on the finer points of old chart paper. The book is really comprehensive, so I’ll just say that the takeaway was between using Arithmetic and Semi-logarithmic scales. Lets start there. Arithmetic scales are probably what your average retail trader is using. It’s simple to understand and not unlike any other chart you probably used in school: Equal distances represent equal increments. But on the semi-logarithmic scale equal distances represent equal percentage changes. On the arithmetic scale the difference between 10 and 20 is 10 and 20, but on semi-log, the difference between 10 and 20 is, you guessed it, 100%; same as the difference between 20 and 40 right?! Confusing as it might initially be, this can be useful for several reasons, and the authors make no effort to conceal their zeal for the matter. The points to remember for semi-log are as follows.
1. Semi-log is better for comparing two securities side by side, to see which one offers higher percentage gains!
2. Semi-log allows for accurate placement of stop-loss orders depending on your strategy.
3. It is easier for displaying trendlines (but not so important that we absolutely have to)
To end in this bullet vein, a few parting points on long term charting.
- Weekly charts are going to follow a high/low format. Don’t worry about open/close prices on these longer scales.
- On these “Major” monthly and weekly charts, we will pay less attention to volume.
- Our chief usage for long term charting will be to plot support and resistance..
Edwards, R. D., Magee, J. & Bassetti, W. H. C. (2007). Technical Analysis of Stock Trends (9th ed.). Boca Raton, FL: CRC Press & Taylor & Francis Group LLC.