How To Read and Understand Day Trading Charts
I work with many new traders day in, day out and many of them say that when they first started, they found day trading charts intimidating. They probably saw some charts while browsing the internet and assumed it was complicated.
On the contrary, I think reading charts is one of the most fascinating aspects of trading and if learned correctly, they are a great asset to have in your trading journey.
Charts built on data have been used for as long as mathematics and statistics have been around. A chart makes data easily understandable, making it more likely to be turned into usable information.
Learning how to read charts, interpreting them to find usable information, and making decisions based on this information can seem overwhelming…
But with practice and the right guidance, you can master them.
In the previous article, we discussed the importance of Day Trading Patterns, and how you should go about choosing one. We talked about how to not get overwhelmed by the various types of day trading patterns out there, and instead to learn how to make your own.
A very important step in learning how to do that is to learn how to read day trading charts. How well you’re able to read charts directly contributes to how well you trade profitably in any market.
Welcome to this new article in my series Investing for Beginners.
I’m glad you’re embarking on your day trading journey with this series and investing your time in learning. Day Trading is so tempting for so many people to jump straight in without much consideration. They assume that by lurking around Facebook groups on stocks, or browsing some articles and listening to the news, they will earn lots of money in a matter of days.
Over 94% of beginners fail because they follow this approach!
Whereas the ones who do find long term success in day trading realize this quickly and I am glad you have decided to be one of them.
Today we will understand more about day trading charts because learning how to read charts is essential to becoming successful in this field.
As a new trader, it’s easy to be unsure of what charts are and which ones you should use. There are plenty of articles out there listing various types of charts but more often than not, they end up confusing new traders. They do not tell you which ones actually work!
The same happened to me when I started and I had no idea how to read charts or interpret them. But then I did a lot of research and practiced, and, today, I am here to share my insights with you.
The key step in your journey is also to practice. The more you look at a chart, the more you understand the chart.
What is a Trading Chart?
Day Trading Charts are visuals that depict how stock prices move and help traders decide when to make their trades.
There are quite a few diverse types of trading charts, and they all show fundamentally the same trading data, i.e. the past and current prices.
I have been more inclined towards using Candlestick Charts because they WORK. You will find a ton of other types on the internet but let me tell you from the outset, they do not work. While it is nice to be aware of them, it is equally important to know how pointless it is to use them.
Types of Day Trading Charts
The three major types of trading charts you will find are:
- Line Charts
- Bar Charts
- Candlestick Charts
Line Charts
Line charts give us a short synopsis of where the price was earlier, but data is inadequate as only the closing price of each time interval is shown. A line chart is simply a line created when you connect the dots after plotting all the closing prices.
They are certainly cleaner to look at but have very little detail to offer.
Line charts are not effective as there’s too much essential information missing. They only depict closing prices of stocks, not the opens, highs, or lows. So the information depicted is very diluted. There is simply not enough information for backtesting strategies.
Bar Charts
Bar charts give you more information than line charts, in an easy to understand format.
They depict where the price has touched within a specified time period.
Bar charts are in fact similar to line charts, but with the added information of high, low, and close.
However, it still offers incomplete information when compared to candlestick charts, which we will discuss next.
Candlestick Charts
Candlestick charts are my default chart to use on most trading platforms and the most successful traders I know use the same. They pack in more data in a single chart than either line charts and bar charts, giving a more holistic look at the situation.
They are an effective visual tool depicting all the changes a stock has gone through within a certain time period.
Knowing how to read candlestick charts gives you a competitive edge.
Candlestick Charts got their name because they look like candles at an assortment of heights with a wick extending from the top and/or bottom. Just as a candle illuminates, Candlestick Charts throw light on very important data for traders to use.
They’re said to have been developed in Japan by Munehisa Homma, in the 18th century and are often used today in stock data analysis.
The anatomy of a candlestick:
- The body: the rectangular part which shows us the open-to-close range
- The wicks of the candle: the long thin lines above and below the body. The wicks depict the high and low on that day. They are also known as shadows or tails.
- Color: this depicts the direction in which the price is moving. Green represents a price increase, and red represents a price decrease.
The data in a Candlestick Chart contains highs, lows, open and close prices. Each candle will show the high, low, open, and close price for a particular time period.
You can notice how the price moved during the time frame of the candle by the color and positioning of the candlestick. The color depends mainly on the color scheme set on your charting platform, but white/black and green/red are frequently used.
- Open: The open price is the first price at which a stock was traded. If the price jumps up, the candle turns green. If the price falls, the candle goes red.
- High: High is denoted by the top of the wick of a candle. It is the highest price that the stock reached in this time period.
- Close: Close is the last price of the stock during this time period.
- Low: The lowest price we saw the stock reach. It is shown by the lowest point of the bottom wick.
Green denotes a bullish candle or a candle that closed above where it opened. Red is a bearish candle. The close is below the open in a red(bearish) candle. This represents a day where markets closed below they opened.
Each candlestick represents a time period.
Your trading platform typically has time periods between one minute to one month. For example, if you select five minutes as the time period, each candle will show the price change for every five minutes.
Similarly, if you set it for a week, you’ll see how the price changed in that week. For instance, a green candle for that week will show it was a bullish week, whereas it’s a bearish week if the weekly candle is red.
Another aspect to keep in mind while reading candlestick charts is to notice how big or small the wick is in comparison to the body of the candle.
If the upper wick is much smaller than the body, we can safely say that even though the market is bullish, there was still some price rejection. The buyers are pushing the price up overall but the price did fall a little bit.
If the wick is much larger than the body, even if the body is green (bullish), we know that the price was pushed up by buyers but there was immense price rejection. So even if the body shows bullish, the market can be bearish in this case.
Overall, there are three things to keep in mind:
- The body
- The wick
- and the relative size of the wick in comparison to the candle body.
A candlestick chart ultimately shows you who is in control in the market at a particular point of time: the buyers or the sellers. Traders can make out the disposition of the market by looking at the color and length of the candle’s body and wicks.
Let’s say the lower wick of a candle is much longer than the body and the top wick is virtually non-existent. A candle shows that the buyers took control of the situation and pushed the price up after it fell quite a lot.
If the open and close prices are at the same point or are very near to each other, then the body will be virtually non-existent. These are special types of candles known as doji candles.
More often than not, this cluster of candles will form a pattern. These patterns are analyzed by traders to make buying and selling decisions. Bullish patterns insinuate that the price is likely to increase, while bearish patterns suggest that the price is likely to fall.
Identifying Trends and Patterns
All candles put together show us market direction based on candlestick charts.
With practice, when you look at a chart and see data plotted in a universal direction, you will be able to make out an overall direction that a stock is moving to
(i.e. what trend the market is following at that particular time. You will also be able to identify and create your own patterns)
Being able to read day trading charts helps you understand the overall trend, form patterns, and make decisions based on these rather than rely on your emotions. Successful traders put in hours and hours of studying, practicing, and learning with a mentor. That doesn’t come by knowing patterns that are already out there. It involves having enough experience and skill to create your own.
And one of the main aspects of achieving this is to know how to read charts!
As I talked about in my previous article (click here to open in a new tab), all the patterns you find online do not work. Finding a day trading pattern in a free article that claims this is what will make you successful is a red flag you need to be aware of.
There’s no secret to day trading success other than puting in the hard work. Yes, you can learn from other people, hire a mentor, and use their proven patterns and strategies. But if you want to create a long term career in trading, you need to learn how to spot your own patterns.
This is why learning how to read day trading charts is so important.
The best way to learn this is to start playing around with them using Paper Trading.
Paper trades are the most important thing that will help you get ready for actual day trading. My students often ask me if there’s a way to practice reading day trading charts without the risk of losing money?
Fortunately, there is. It’s called Paper Trading.
While you’re building your aptitude and honing your skills, paper trading allows you to replicate actual trading. The best way to learn how to trade is to actually perform the trades. But it can be done without having to risk losing actual money.
It’s like how a brain surgeon would simulate and practice a risky surgery on an AI simulator without actually performing the surgery, to control the risk. Trading is risky at the end of the day and I would never recommend someone jump into it without proper practice. A person needs to make mistakes first using paper trading in order to learn what to avoid.
Paper trading looks exactly the same as trading in the real market so you get the feel of it without the risk. You’ll learn a lot about your trading psychology, your strengths and weaknesses, what you need to focus on, and what you need to improve.
With the increasing popularity of online trading platforms, almost every one of them offers free paper trading accounts so there is absolutely no excuse to not practice before jumping into the actual thing.
It is better to mess up during paper trading and learn than to fail in the real market. Take paper trading seriously and it will shape your mind to take real trading seriously. If you don’t take paper trading seriously, you run the risk of being casual even when you actually trade.
That’s a risk no one should be taking.
There is no glory in practice, but without practice, there is no glory. — Unknown
Trading is a serious business and anyone who works with me takes it seriously. Articles like these can only give you an overall idea of concepts, but the traders who are truly committed to succeeding work with a mentor.
Practice and experience are good teachers, as long as you have a committed teacher guiding you along the way.
This article gave you a basic understanding of how to read trading charts and what exactly these graphs show. But when you first get started, these charts can remain a little overwhelming, no matter how many articles like this you read.
Having someone by your side to guide you will help. This is why I created the Freedom Challenge because there is immense need for a comprehensive program for dedicated traders.
In order to be successful in the world of trading, you need insider insight that you will not find for free on the internet. If you’re interested in learning more, visit this page and sign up for more details.
Otherwise, make sure you subscribe to my YouTube channel where I share weekly trading tips and insights, and sign up for my free newsletter that I write for new traders looking to turn trading into their primary income source.
