How to Swing Trade Summary (C7): Charting Basics

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Technical analysis is an important skill to learn for a swing trader.

To the untrained eye, looking at all the charts can seem like a different language, and indeed it is.

But it is a language that can be easily interpreted with a bit of study and practice.

Technical analysis is based on the principle that past price movements are a predictor of future ones.

To understand past price movements, you must first learn how to read the technical chart of an asset.

Candlesticks are the most common way for swing traders to read charts. They are a visual representation of the traders’ collective psyche about the value of the asset.

A single candlestick represents a portion of time. How much time depends on what you set it to. It can be anything from seconds to months. Most swing traders will use the 4-hour or daily time frame.

Each candlestick has a ‘body’, which is the wide portion of the candlestick, and up to two ‘shadows’ (also known as wicks or tails), which are the thin portions protruding from the top and bottom of the body.

The body represents the opening and closing prices of the asset for the time frame of the candlestick. If it is green, it means that the asset rose in price for the time period of the candlestick (bullish). If it is red it means it fell (bearish). The colors can be different depending on settings, but green and red are the most common.

The wicks represent how far beyond the opening and closing prices the price got during the specified time period.

The shadows are not always present. For example, if a stock closed at the extreme high for the time period, there wouldn’t be an upper shadow because the top of the body was the highest high.

A bar chart is functionally the same as a candlestick chart but the time periods are represented with bars instead of candles.

The candle’s body is replaced with a vertical line with small horizontal lines representing the opening and closing prices.

Whether you use a candlestick or a bar chart is personal preference.

Candlestick charts (or bar charts) represent the psychology of the traders.

There are essentially three groups of traders: buyers, sellers, and the undecided.

Just like in any type of commerce, the buyers want to pay less and the sellers want to charge more.

The ‘bid’ is the buyer’s offer price. The ‘ask’ is the seller's preferred selling price. The difference between the ‘bid’ and the ‘ask’ is called the ‘spread.’

As a swing trader, your goal is to figure out who has stronger conviction between the buyers and the sellers and then join sides with who you think will be the winner.

While you are figuring it out, you are essentially part of the undecided group.

In order to figure out who the likely winner is, you need to search the charts for indicators of bullish or bearish action.

The candlesticks (or bars) are one place to find these indicators.

The larger the body and the shorter the tails towards the candlesticks trend, the more conviction there is in the trend.

For example, a long green body with a small upper wick is a bullish signal. Conversely, a long red body with a small lower wick is a bearish signal.

When the trend is bullish, you want to buy and hold. When it is bearish, you want to sell.

The volume bar is usually underneath the candlestick chart. It represents the number of shares traded. The taller the bar, the more shares have been traded for that time period.

Use increasing volume as a confirmation to the trend of the candlesticks.

There are many different candlestick patterns, but only a few are consistently reliable, and even then they are not sure ‘tells’ of what will happen.

Always look for several indicators to confirm your interpretation of the charts.

Reversal patterns signify that the price trend is going to change, i.e., from bullish to bearish or vice versa.

An engulfing pattern can be either bullish or bearish.

It is represented by a short candle followed by a long candle of the opposite trend which fully engulfs the short candle.

If the long candle is bullish, then the trend is turning bullish and it is an indication to buy. If the long candle is bearish, then the trend is turning bearish and it is an indication to sell.

It is a good idea to wait for the next one or two candlesticks to confirm the movement before making the trade. Also look at the volume. The short candle should have a lower volume in comparison to the larger candle.

When trading long (bullish) on the engulfing candle pattern, your stop loss should be no lower than the low of the engulfing candle. Use resistance levels for possible profit take points and then calculate your risk/reward ratio.

A doji occurs when the stock’s opening and closing price are almost the same. The length of the wicks depends on the price action.

When the lengths of the wicks are of a relatively equal size and form a cross shape, it is a reversal indicator.

So if the previous candles were bullish, a harami cross can indicate a change to a bearish sentiment.

Volume confirmation is important. You should see a strong volume preceding the cross with a drop on the cross.

The gravestone and dragonfly are two other types of reversal doji patterns.

The bodies are small, and they have a single long wick pointing in the opposite direction of the reversal trend.

A dragonfly has the T shape and is a bullish indicator found at the bottom of a downtrend. The gravestone is the opposite.

With either of these, volume should be equal or larger than the previous period.

On a dragonfly, go ‘long’ (buy) with your stop loss at the bottom or 50% (more conservative) of the tail, and check resistance for your take profit level.

Gaps occur when the opening price of a stock is higher or lower than the previous close. This is usually because of price action occurring between trading sessions.

A gap and go is when a stock opens significantly higher or lower than the previous closing price and then continues to move in the direction of the gap.

A gap and consolidation is when the price will start to move sideways after the gap. It may then continue in the direction of the trend. Sometimes it can break out in the opposite direction.

A gap and fill is when traders will take profits gained which in turn reverses the gap, essentially ‘filling’ it.

Trading a gap is difficult after they have happened.

On the first day of a gap up, you can go long towards the end of the day if you see the bull trend is continuing.

Alternatively, you can use the gap and fill. Often, wherever the stock gapped to will become the new level or resistance or support.

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