Using Line Charts to Reveal Hidden Information | FXTRADING.com - International

Line charts are unlikely to be used to trade directly from a chart by most traders, although they are popular for comparing securities and general analysis. However, as we shall demonstrate, a line chart should also be considered by traders to complement their usual analysis, as they can reveal information that has been overlooked if they focus exclusively on candlestick or bar charts.

By default, our MT4 trading platform offers three chart styles:

  1. Bar Chart (OHLC Chart)
  2. Candlestick Chart
  3. Line Chart

To use a line chart, select icon (3) in the ‘Charts’ tab at the top of the MT4 terminal, or use the Alt +3 keyboard shortcut.

Visually, line charts are the easier to grasp, and they simply plot a line between the closing price of each period. For example, the daily chart (D1) would join the closing prices of each day, or an hourly chart (H1) would connect the hourly closing prices.

 

Due to their simplicity, information is more easily absorbed which is why you will frequently see them on the news and in financial media. Line charts also make it easier to compare multiple markets or data sets to each other or identify trends or price patterns. It should be remembered that technical analysis (TA) started with a simple line chart, so many of the classic TA books written referred exclusively to line charts.

 

Western Patterns on Line Charts
Many of the patterns used on candlestick charts and bar charts today actually originated on the line chart, which includes Western patterns such as double tops/bottoms, wedges, triangles and even Elliot Wave analysis. Whilst this is a dying trend, it can be beneficial to refer to the line chart, particularly when price action is messy. Forex crosses such as NZD/CAD, AUD/NZD, GBP/EUR can go through phases of messy price action yet can reveal hidden inflation when seen with a line chart.

In this example, AUD/NZD price action appeared very choppy on the hourly chart. No apparent pattern was visible on the bar chart and support and resistance levels were fickle. Yet when seen on a line chart, a triangle formation appeared which saw perfect tests of the upper and lower trendlines, along with a retracement back towards the triangle then subsequently moving swiftly lower.

 

The Importance of Closing Prices
Large traders such as institutional firms, banks, sovereign wealth funds, pension funds etc generally do not assess intraday price action. But they will pay attention to the closing price of a day, week, month and quarter. As these traders are significant enough to move markets, traders of all timeframes should pay attention to these milestone levels, as prices can gravitate towards them and provide support and resistance levels.

In this example, the DAX 30 (DE30) closed at 12,772.11 in September 2020, which shows how the candlestick chart interacted with this price over the next few weeks.

  1. On 1st October, the high of the bullish hammer respected September’s close as resistance. The following session opened above the level, yet the session low respected the September close as support before trading higher.
  2. Despite an intraday break beneath the September close, on the 15th October the session closed just above this level.
  3. The low of the session on the 16th October respected the September close as support, and the following two sessions closed on this key level.
  4. After an initial break beneath the September low prices retraced towards it, and it provided resistance before moving swiftly lower.

 

Comparing the RSI to the Line Chart
It is frequently overlooked (or forgotten) that some momentum indicators such as RSI (Relative Strength Index) use closing prices as the basis for their calculation. Yet all too often, analysts will identify a bullish or bearish divergence with price action yet compare it to the swing highs or lows. Usually it doesn’t present a problem as the divergence can also appear on the closing price, but it won’t always.

In this example, the Nasdaq 100 (USTEC) has formed a bearish divergence between the highs of price action and the RSI. The recent high broke to a new high, whilst RSI remained flat. However, if we refer to the line chart, prices also remained flat which shows there was not a divergence. Whilst the closing prices can be seen on the candlestick chart, the line chart makes the non-divergence easier to identify.

On a sidenote, a line chart can be overlaid a bar or candlestick chart by using a 1-period moving average, and selecting Properties > Common tab > Uncheck ‘Chart on foreground”

 

Line Charts Can Filter Out Too Much Information
As good as line charts are, they do have their limitations with an obvious downside being that they filter out price action extremes. This means important structural highs or lows will be missed which are usually required to make trading decisions upon.

To use an extreme example to demonstrate, in January 2019 there was a flash crash in the forex markets which made a notable impact on JPY, AUD and NZD pairs. In particular, AUD/JPY fell over 400 pips in a matter of minutes. However, by the close of the session AUD/JPY has recouped most of the day’s losses and was just -0.8% lower whilst intraday low had fallen -5.9%. This means there was a large difference of 398 pips between the session close and the session low.

Had a trader focussed exclusively on the line chart they would have missed this extremely volatile candle. It’s also interesting to note that prices went on to find support around the flash-crash close price in May 2019 and then then the flash-crash low in August 2019.

 

Gaps Do Not Appear on Line Charts
As line charts connect all closing prices, price gaps will be missed. This is less of an issue with forex markets as they tend to generate far fewer and smaller gaps than other markets. But if a line chart is used exclusively on a market prone to price gaps like the DAX, lots of vital information will be missed.

Ultimately, if a trader wants to identify short-term reversal patterns, they will either have to use a bar chart or candlestick chart. Whilst a line chart is good for filtering out noise, it can filter out too much and not be able to pick up patterns such as engulfing candles, morning star reversal patterns or any other pattern which requires a high or a low to identify it. But whilst we wouldn’t expect a trader to exclusively use a line chart, it can provide important information to a trader that may have been missed otherwise.

 

Summary

  • A line chart filters out noise. This can be an advantage or a disadvantage, depending on the situation.
  • Line charts can reveal hidden levels of support or resistance which can be easily missed on bar or candlestick charts.
  • Trends can be easier to identify on line charts, particularly if price action is choppy on that market.
  • Many western patterns and Elliot Wave analysis were first created using line charts. They therefore can reveal hidden patterns.
  • As no high or low is included, line charts will not reveal structural swing highs or lows.
  • Gaps do not appear on line charts as all closing prices are connected. Therefore, the trader must refer to a bar or candlestick chart to perform gap analysis.
  • Line charts can provide important information on choppy markets, such as forex crosses.
  • Markets are easier to compare using line charts. They are also useful to compare financial data to economic data.

 

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