Before we start please take a brief moment and look at the following two stock charts carefully!
Modern art or a stock charts? You decide!
If you believe that’s how a price chart is supposed to look like for you to be recognized as a stock trading professional, read on as enligthment awaits you.
If you even fell in love with the visuals at first sight and would pick appealing as a suitable adjective to describe it, you might as well stop reading here as I won’t be able to change your opinion anyway.
However, if you would rather label it appalling, then this article is surely for you and chances are that you find the following information quite helpful.
As a price action trader you want to make sure to receive the message from the market loud and clear without any difficulties or distractions. What follows are a couple of practical and field-tested methods to achieve that.
Bars or candlesticks
In my opinion classic high-low-close-open (HLOC) bars work best because they provide you with pure price action. The open price isn’t mandatory and on most days you can neglect it. However the open does come in handy on overnight gaps, so you should still display it.
Candlesticks and Regular bar charts
Candlesticks can work too but they come with a built-in filter with more weight being put on the net progress of a bar and less on the true range, represented by a filled box and thin wigs and tails, respectively.
This might be reasonable with the natural overnight and weekend breaks of the market but it makes zero sense with other timeframes.
It is also harder to see price changing character from sloppy to tight because you need to consider the tails and wigs as well.
If you believe that the net progress of the day is more important than the true daily range feel free to use candlesticks.
I prefer bars, where a real change in character is much more easy to identify. This is especially true when you browse through many charts in rapid fashion.
You also want to avoid biased colors like red and green. We are primed since childhood that red means danger –think about signal lights– and you want to avoid to trigger such a fortified bias as a trader.
Falling and rising price are both equally important parts of the game and there should be no label such as good or bad be attached to it. Pick unbiased colors for your charts!
I still use blue and magenta from my days with MarketSmith seven years ago (overloaded charts but at least they got the colors right!) but you can simply pick colors you like.
Example of alarming and calming colors
You have to make sure that the price scaling is logarithmic as this allows you to better capture the significance of price moves at a glance.
WITH A LOGARITHMIC CHART THE PRICE DISTANCE MEASURED ON THE CHART IS ALWAYS PROPORTIONAL TO THE PERCENTAGE MOVE NO MATTER WHERE YOU ARE.
A log chart for example, is the foundation of the clothesline which I discovered as being an extremly profitable price target method.
A steady positive slope on a log chart equals a steady growth rate which means that price is actually advancing exponentially.
Logarithmic (Log) Chart and Regular Scaled Chart
This comes in handy because we measure the growth of earnings and sales as a percentage based quaterly growth rate as well. Imagine, you own a stock with a constant EPS growth of 10% per quarter showing a constant price advance of 10% per quarter as well.
If the price advance suddenly accelerates it can be a hint that good news is around the corner- perhaps a future EPS or sales explosion. With a log chart such an acceleration is easy to spot while it would be nearly impossible with a regularly scaled chart (see AMZN below as an example).
AMZN climax above the clothesline
Reference for price
The best references for price are simply horizontal support and resistance lines carved out by prior arguments between buyers and sellers.
If these are not available, your second best bet is a smoothing of price action on an end of bar basis better known as a moving average.
Illustration of price adherence to moving averages and support & resistance levels
Back in the pre-computer days the construction of a simple arithmetic moving average was the most fancy thing you could do with a printed chart without too much hassle.
The 50 day and 200 day moving averages are the most prominent examples but the 10 day and 20 day are also widely followed these days.
You must be aware of major support and resistance levels at all times.
Other Indicators which require some more computing power (stochastics, ADX, MACD, RSI…) are simply not followed as much.
They provide you with redundant information and try to create precise signals out of thin air which bear no significance in real trading.
Clearly overloaded, but at least the price action is pure in this example
Watching them for divergences might contain some value but in my opinion they just consume precious attention without providing an equal reward.
If you have difficulties recognizing strong price action it can help to know how stocks perform against the broad market by using some sort of relative strength comparison as a chart overlay (Not shown here and not to be confused with the Relative Strength Index RSI).
I used it in the past as it was a part of my first charting/research bundle but to be honest with you, it never really struck me as anything useful.
Generally the fancy indicators are often simply second grade information and they clutter up your chart to a degree which can make it impossible for you to extract any useful information at all in a reasonable amount of time.
Supply & demand
Volume information is mandatory because supply and demand is a fundamental law in economics and you need a tool to provide you with information in that regard.
Identifying support and resistance levels isn’t rocket science, and can be easily done with regular volume bars and price action.
A more advanced way to display similar information is given by Volume-by-Price or how I call it Peak Liquidity-Level (short: PLL) chart overlay which shows the intensity of the fight between buyers and sellers at any given price.
Liquidity Levels (LL) Overlay and a regular volume chart
You simply check the ratio of the tilted up (blue) and down (magenta) volume bars when price is in a sideways range. If there is more selling than buying volume without a decline in price, it would be a hint that all that selling is absorbed by buyers.
Once the sellers are out of the way, price is ripe to explode higher through the vacuum of sellers.
I believe that we are not made for multitasking and that it is usually much more efficient to allow only one piece of information to hit your synapses at a time.
Please recall that even Johnny 5 read only one book at a time. Liquidity Levels will clutter up your charts quite a bit but it is a powerful tool nevertheless. I don’t always display it due to longer computation time, but you better bet that I turn it on whenever I want to identify a major turning point, be it intraday or on higher timeframes.
If you decide to use it you’d still need regular volume bars in order to know when the volume actually came in.
When it comes to timeframes I like to focus on the daily and then switch to the weekly, to check if there is old overhead supply or a gap to be filled.
Intraday charts (think of 5 or 15 min intervals) can help to identify intraday turning points and you want to display session breaks and after hour trading.
HAVING THE DAILY NEXT TO THE WEEKLY IS GREAT IF YOU CAN HANDLE THE INCREASED INFORMATION INPUT.
I don’t believe that monthly charts can help improve your edge but I am actually looking into them right now, so this is work in progress. (Update January 2021: I wasn’t able to improve my trading by looking at the monthly charts, hence I dropped them again!)
Daily charts are your bread and butter business and they flow with the daily rhythm of us humans. Remember that ‘there is always tomorrow’ and sometimes you simply have to ‘consult your pillow’.
Setup your stock charts to protect your vision
You may wish to switch to a dark colored chart theme to protect your eyes. However, I am so used to the white background that I wasn’t able to make the transition yet!
But I do use night mode on twitter all the time.
You should also consider grabbing an eye friendly screen with a comfortable resolution or even a low latency time.
When you are browsing charts at night or when it is dark outside simply tune down the color temperature of your screen from >10000 Kelvin (bright blue sky) to 2700 Kelvin (candlelight) as this will calm you down and relieve the strain on your eyes.
Dark and light theme
Update June 2020: I finally made the leap and switched to the “dark side” after the strain on my eyes became too much to handle. Here is how my charts look like now. I am still not sure about the yellow as the contrast is poor sometimes. I might tweak around with that.
How justgetflux alters your colors at night (schematic illustration)
I use Justgetflux for many years now but I suppose that there are other tools available as well. You can also buy glasses which will filter out the higher color temperatures.
Browsing through as many charts as possible is taxing so you must protect your vision, especially when you are not in your twenties anymore.
How our Brain processes information
The next step after setting up the chart is to make sure that you can work with it in real time, under pressure, in the tense and unpredictable enviroment that is the stock market. You must be able to quickly alter the scaling in order to get a fresh perspective on things.
What follows is a short discourse about the principles of how we process visual input and how this can be exploited by us technical traders.
Please be aware that while we humans excel at detecting visual changes, we have our brains switch into sleep mode when we watch a still life due to our built-in attention filter.
To be more precise one must realize that the brain actually captures every price bar we see on a chart instantly but our built-in attention filter decides if the signal is worth to be forwarded to one of the cognitive processes.
This is useful in real life and can sometimes be useful in the markets as well but it certainly doesn’t help when your screen is flashing at you all the time like a disco-ball. In order to allow your brain to process the information you simply have to open a still chart and look at it for a while.
Rescaling the chart a couple times while doing this, creates a fresh visual stimulus for your brain thus allowing it to complement your conclusion layer by layer.
AVOID FLASHY VISUALS IN YOUR CHARTS WHICH WOULD TRIGGER YOUR ATTENTION FILTER
Speed and Ease of Use
You certainly want reliable real time data and the ability to quickly browse through as many real time charts as possible.
YOU ALSO NEED A CHARTING TOOL WHERE YOU FIND IT NO TROUBLE TO MAKE ANNOTATIONS THROUGH-OUT THE TRADING DAY IN THE HEAT OF ACTION.
If the annotation tool is clunky and requires too much effort a trader tends to neglect it intraday and only uses it after the close or over the weekend.
If you have a great memory it might work for you but for me it simply doesn’t and I am dependent on my ability to quickly make notes on the charts I am looking at.
There is nothing worse than having to navigate sluggish charts while the market around you implodes thus calling for quick and desisice action.
Get it right from the start
No matter which charting service you use, you must get it right from the start in order to speed up your learning curve.
Being able to grasp all the little price and volume clues will come easily after a year or two but learning how to prioritize the clues and drawing a reliable conclusion requires years of practice.
At least I wasn’t able to find any shortcuts during my own journey where I spend roughly 8000 hours over the course of 10 years of trading real money.
One day I suddenly realized that I can actually read a stock chart now.
Be assured that you will have a hard time to get in quality practice hours if you overload your visual sense with messy charts.
You need to go over as many price action bars as possible over the years to develop the ability to differentiate between bullish and bearish action at a glance.
This is a vital skill for any technical trader.
The higher your chart reading capacity (read: throughput), the faster you’ll travel on the learning curve.
You must accept that there is no holy grail indicator which you could possibily discover beforehand, you simply have to study price action just like an surgeon has to study the complex anatomy of a human.
There are no shortcuts and you must get it right from the start to make quick progress on the learning curve
- Protect your vision (Proper screen, dark theme, clean charts)
- Watch a still chart and rescale often to get all the clues
- Have a dialogue with the market by reading many many charts
- Provide your brain with raw price action and don’t prioritize anything in advance!
- Display the major reference levels for price (support & resistance and the common moving averages)
- Use a logarithmic chart with a neutral color scheme to remain objective about price movements
- Make sure your charting tool is real-time, fast, flexible and reliable