Trading Charts and their Construction
Now that we have studied the six basic tenets of the Dow Theory we start with the basic foundations of technicals to enable us to form views on the markets. Keep in mind that the concepts you learn here are applicable to any markets that can be charted. We discuss the different types of charts available here but before we do that let’s take a look at the concept of a tick in the FX markets and how these ticks are aggregated to create the charts
Differences in the construction of Stock vs Forex Charts
In the stock markets, prices are the actual traded prices obtained from the exchange, the prices at which stocks are bought and sold. However, since forex markets are OTC markets price information does not pass through an exchange. We have seen before that market makers have a Reuters or Bloomberg dealing system as well as a price/information system. This price information system can be updated by participating dealers at banks. For example, for the AUD you could have dealer banks in Australia such as NAB, ABN Amro Bank, Westpac and even foreign banks in Australia like Citi, Wells Fargo, Barclays etc as participating banks, banks in Hong Kong, Singapore all participating in updating AUD.
These participating bankâ€™s AUD market makers would constantly update the AUD against the USD when convenient as indicative prices. Let’s see how this works. Its important to note that these are indicative prices and not traded prices although they could be the same. But the intention is to update indicative prices.
Assume AUD is currently at 0.7551-2.
Dealer 1 in Australia quotes 07553-4
Dealer 2 in Singapore is looking to sell AUD and seeâ€™s Dealer 1â€™s price of 3-4. If Dealer 2â€™s bank has dealing limits with Dealer 1â€™s bank, Dealer 2 could call dealer 1 for a price. If Dealer 1 quotes 3-4, Dealer 2 could hit dealer 1 at 3 or pass the quote. However, dealer 2 now knows that the AUD has moved higher. Dealer 2 now wishes to test the market further and updates his price at 0.7555-6. Now, Dealer 2 could see a couple of banks calling for a price in AUD. Dealer 2 could honor his quote or quote say 4-5 to see if there are any takers at 5. Since he is already long he wouldn’t mind being taken at 5. If he does get taken at 5 he knows the market has moved higher and would quote the next bank at maybe 6-7 pushing the AUD higher till he either gets given. If he gets taken again, AUD moves even higher and the price is updated accordingly.
Unfortunately, there are prices that are updated wrongly by dealers (called outliers) to push the markets higher if they think the market is overly short or bring the markets lower if they think the market is too long. However Reuters, Bloomberg has some checks in place that identify these outliers and they are not included in the price data.
Construction of Trading Charts – Concept of a Tick
Each of these price updates is called a tick. Therefore one tick is one price update and one second could be made up of multiple ticks in a volatile market with so many market makers updating. These ticks are stored in a database and aggregated according to their timestamp for each currency. Once these price ticks are captured it is very easy to aggregate them to minute, hourly, daily, weekly, monthly and yearly charts using the timestamp.
Trading Chart Types
Now that we understand how these charts are formed in the FX markets lets quickly take a look at the various types of charts commonly used
- The Bar chart – each price action is represented by a bar with the highest point being the high of the day, the lowest point is the low of the day, the left tic is the opening price and the right tic is the closing price.
- The line chart is a line that simply connects the closing prices of each bar
- The point and figure chart show alternating prices of xâ€™s and oâ€™s. The xâ€™s show rising prices and oâ€™s falling prices.
- Candle Stick chart is similar to the bar chart except that the candlestick has a body which has two different colors – white and black, or green and red. The body represents the price action between the opening and closing prices. For rising prices when the closing is higher than the opening, the body color is white or green. For falling prices where the closing is lower than the opening, the body color is black or red. Price movements above and below the body are called shadows.
You can watch the free training on Chart Types below
Introduction to Volume and Open Interest
Let’s also discuss volumes and open interest pertaining to financial markets briefly.
Volumes represent the total amount of trading activity during the day.
Open Interest is defined as the number of outstanding contracts held by market participants at the closing of the day. Open interest if the number of contracts held by the longs or shorts but not both.
However open interest and volumes are easily available for currency futures and not plain vanilla FX as the FX market is an OTC market. If at all you wish to study open interest and volumes for currency pairs you could look at the currency futures market which is correlated to the spot markets. There are FX rate providers who do provide volumes and open interest for each currency pair. It might be a good idea to determine the source of this data before blindly trusting it.