The candlestick chart should be your best friend.

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An excuse — albeit a poor one — for using line charts include paralysis by analysis. The state where a trader may have so much information that they don’t know what decision to make.

This is a dangerous falsehood that cripples traders and amateurs every single day. While overcomplication exists, a line chart exists in a place of oversimplification. It deletes where it shouldn’t and omits an inability to represent.

People accept line charts due to invisible authority, without question nor reason.

Somewhere between overcomplication and simplicity lies a necessary amount of complexity that one needs to understand.

This equipment, when trading, or making any wise investment on the stock market, allows us to make better decisions based on as much information as possible.

We call the trajectory, between understanding and equipping, the learning curve.

Going down a list of chart types, you’ll find an assortment of different things with strange names.

Your default will be the line chart. Among those types, you’ll find charts with areas, strange shapes, and bars. You’ll find something called the candlestick.

To better understand why the candlestick chart gives us more information, we must compare it to something that’s awful. However, without understanding how bad something is, we won’t truly know the difference.

Familiarity breeds complacency, and, in that complacency, we fall into a pseudo status quo that inevitably hurts us in the long run.

That is why we start this thought project with an overview of the line chart and the information we forgo by choosing it.

Let’s get started with a line chart.

This is ACB’s line chart, computed daily since November 21, 2019.

Above is a line chart for Aurora Cannabis. As with all equities on the stock market, trading happens at multiple values within each day.

This line chart above, however, crosses only one point across the x-axis for every one point on the y-axis. This means that, even though many prices and many trades were seen that day, we only get one value for each day:

The closing price for each trading day. In other words, if we are looking at a line chart, we are essentially looking at the moving averages of a stock’s daily closing prices.

We have these fundamental questions beyond a closing price for each day when looking at companies:

  • What was the range of prices traded throughout the day?
  • What was the range of prices traded throughout the day?
  • What was the range of prices traded throughout the day?
  • Did the day end up with it trading above the open price or below it?
  • What if the day ended with the closing price equaling the opening price?
  • How far above or below the open and the close had the stock traded on a particular day?
  • How has the range of prices trading at a weekly or daily level change over time?

When you begin to ask some of the more critical questions, you realize that the line chart crumbles and falls short. While we can look above to check for what the open price, closing price, high and low were, we’re looking at an overly simplified model that sells us short on the information we might be looking for.

Enter, candlesticks.

There are four components we are familiar with immediately when looking at a candlestick: the high, the low, the close, and the open. Now, it’s all read in a single piece of the block on a chart. Notice that, depending on the coloration of the rectangle, the close and the open positions are switched.

This makes intuitive sense, since a green, or open block, represents a trading day where the close was higher than the open. And, a colored, or red block, represents a day where the close was lower than the open. The three additional components are explained fairly naturally:

The upper shadow represents the range of trading prices between the open (or close) and the highest price traded.

The lower shadow represents the range of trading prices between the open (or close) and the lowest price traded.

The real body represents the range of prices traded between the close and the open.

Additionally, we have times where the close and the open prices can be the same.

Depending on the location of the horizontal line, we can absorb information about where we traveled throughout the day before ending. It tells us more than a line chart would with relatively little graphical complexity.

Graphs are layered, too. Even with line charts, we understand that we are looking at aggregations of prices condensed into units of time.

We might look at closing prices each day for a year, or each hour for a day, or even each minute for an hour. Depending on how we choose to aggregate, we will notice that the candlestick chart always gives us more information, regardless of the layer we choose to exist in.

Above is the candlestick chart for Aurora going back one month. The candlesticks themselves are aggregations for each day’s prices, and the bars below indicate the volume of shares traded on that day.

Here is the same chart represented as a line. In this graph, we have connections between the days, but, as we see with the candles, these connections disconnect us from reality on any given day. We never know how far Aurora went on a particular day, we don’t know the range of values that it was traded at, nor do we understand if the volume renders more or less volatility in the prices for a given trading day.

While we see three straight days of a rapid increase in stock price, the line chart makes it seem as if it was connected and smooth.

The candlesticks, on the other hand, tell us that the opening prices of each consecutive day were above the previous day’s high.

This means that Aurora’s price values on May 14 didn’t exist on May 15, and neither May 14 nor 15’s prices existed on the 16th. This tells us valuable information about the opening prices that we wouldn’t know with line charts.

Line charts are friendly by appearance. They look simple, straight to the point, and condensed. However, in all that simplicity, it loses basic transparency. Its friendliness begins and ends with appearances. In the end, it’s going to betray you.

When it comes down to it, the candlestick chart has your best interests in mind. Neglecting it is only going to hurt worse later.

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