Newsom on the Market

By Darin Newsom
DTN Senior Analyst

In our ongoing discussion of lines we've talked about how they can be moving in one of three directions (up, down, sideways) and how plotting these lines on three different timelines (daily, weekly, monthly) gives us three different types of trend to study (minor = short term, secondary = intermediate term, major = long term). Recall from last time, many of my studies are based on weekly charts due to the Goldilocks Principle (daily charts are too hot, monthly charts too cold, while weekly charts are just right). However, as most of you look at your electronic charting system, you may be faced with another choice among the three alternatives.

I use DTN's ProphetX system. It is top of the line, trader quality, and more non-traders are becoming interested in the system as a better understanding of technical analysis spreads out of the cities into the countryside. Those familiar with my Technically Speaking blog on DTN will immediately recognize a DTN ProphetX chart. If you want to build your own weekly charts (or monthly, or daily) and you click on the "Chart Type" icon, you immediately have to make a choice between Candlestick, BarChart or LineChart. Some will say, "But a chart is a chart? How can these be different?" Trust me, they are, and here's how.

Candlestick charts are quite likely the oldest form of technical analysis known to man. Originating in Japan, possibly in the 1600s or 1700s, they were used to study price action of "empty rice," or the world's first futures (pg. 277, Schwager on Futures/Technical Analysis, 1996 edition). Candlestick charts consist of a "real body" -- the opening and closing prices -- and "shadows" -- the high price and low price for whatever time period is being studied. Traditionally a light-colored real body reflects a higher close than open. A dark colored real body means the closing price was below the opening price. All of the different varieties of candlestick patterns are created by the color of the real body and how this body relates to the shadows on either end, with the individual picture as a whole called a "candlestick line."

It stands to reason that plotting a number of these candlestick lines together on some sort of graph creates a candlestick chart. However, there's a key difference between candlestick technical analysis and modern technical analysis, and that is the study of trend. In candlestick charting the importance is placed on each line's potential pattern, not necessarily how today's high correlates to yesterday's high, or this month's low to last month's low. Each timeframe charted can create its own pattern with its own meaning -- patterns that can be confirmed by subsequent individual candlestick lines. I blame this lack of interest in trends to the fact candlestick analysis was likely developed before Sir Isaac Newton came around with his First Law of Motion.

Modern bar charts are what most people picture when they think of technical analysis. The information is the same as in candlesticks -- opening price, closing price, high, and low -- but the emphasis is different. Modern bar-charting is more interested in high and low prices every day, week, or month. And the lines connecting these highs or lows -- trendlines -- give us some of our favorite technical analysis patterns (head-and-shoulders, flags, pennants, support and resistance, etc.). But it's also these modern bar charts that technical analysis detractors have the most fun arguing against, with their con comments twofold. First: It's no more a science than reading tea leaves if it is so subjective that every analyst sees something different. The old story of the Blind Men and the Elephant is oft repeated, with great joy. Second: The anti-technical analysis crowd is happy to point out if chart patterns and signals are so objective then the "science" is self-fulfilling, due to everyone who believes in it reacting the same way. While I've argued with both camps over the years, we'll leave that discussion for another day.

There is an old market saying: "The only price that's important is the closing price." Traders disagree, as they look for opportunities between extremes of daily (weekly, monthly, etc.) highs and lows. But from a risk management perspective, and to keep chart analysis as simple and straight forward as possible, all we need to construct a line chart is the closing price. The line that connects all these closing prices is what we look at to determine whether or not market price is moving up, moving down, or moving sideways. If I'm sitting in the cab of a tractor or combine, or at a desk in a bank, or even checking my DTN system when not feeding livestock, the simpler the better. If all I need to check is one price each day (or week), that's better yet.

Reducing a chart to just the close, or a line chart, gets rid of much of the noise in the market. Basing that chart on the closing price every week, usually Friday, reduces the noise even more. This is the type of chart I use when studying futures, cash, basis, seasonality, volatility, and futures spreads every day, every week, and every month on DTN.

Darin Newsom can be reached at darin.newsom@dtn.com

Follow him on Twitter @DarinNewsom

(CZ/ES)

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