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Part 1: What is a candle graph and why use it?

The following is what’s known in the business as a candle graph and it is the overwhelmingly most commonly used way to chart a stock/look at what a stock is doing because it shows the three most fundamental things you need to know about a stock when analyzing it:

Its price, its volume, and its volatility.

It’s called a candle graph because it shows its data by using indicators that look like little candles:

[ATTACH=full]121887[/ATTACH]

Now there’s actually a few different types of candle graphs but we’re going to use what are called “heikin ashi” candles (or just “ashi candles” for short) in this example and to those who don’t know any better it all looks absolutely terrifying, but it’s actually really easy.

What candle graphs show is a combination of both the path a stock is following (so its actual price) as well as the volatility (how much a stock is bouncing around in price) of a stock within a given time period, and then the volume of the stock traded within that time period is overlaid as a bar graph at the bottom of the chart.

As you can see, the price and volume indicators in the graph look like little double-ended candles with a wick on each end, and it is actually both the “wick” section as well as the “wax” section that communicate that volatility information to us.

What the ends of the “wax” sections of the candles show is the open and close price of the stock in the given time period. So in this case, if you look to the top left of the graph you’ll see a little “1m”, which means I have set the graph to show the candles in one minute time increments, but the cool thing is that you can set them to whatever you want – if you wanted to set the graph to five minute increments then you can do that. If you wanted to set it to ten minute increments then you can do that too – and so on and so forth.

So what the wax sections of these little candles show is what the stock price was at the open and close (so the beginning and the end) of each of these one minute time periods. Make sense?

What the “wick” sections of the candles show is the maximum and minimum prices the stock traded at within this time period. 

Now a stock might have been at its lowest or highest at the open and/or the close of the time period, which means that there won’t be any wick section to show for that particular candle, so just remember, if you see a candle that’s missing a wick (or both wicks) that’s not an error, that’s just a candle where the open and/or the close number was the maximum or minimum in that time period.

The other thing that you’ve probably noticed about this graph is that the candles are coloured. Again, this is not an accident or error because the colours also tell us information.

The way a heikin ashi graph differs to a normal candle graph is that while a normal candle graph simply compares the close & the open as it moves from one time period to the next, a heikin ashi graph uses the average of the stock price within that time period to do so and then colours the candle either red or green to indicate whether a stock went up or down respectively on average compared to the previous time period.

So if the stock on average went up, then the candle for that time period will be green, and if it on average went down, then the candle for that time period will be red.

The reason why it’s called a heikin ashi graph is because this type of graph was developed in the 1700’s by a Japanese chap called Munehisa Homma and heikin ashi means “average bar” in Japanese.

And yes, if you want to know what a simple line graph would look like you can plot (overlay) that too and your graph will look like this:

[ATTACH=full]121888[/ATTACH]

But in my opinion, this isn’t necessary.

As for the bars at the bottom of the chart, these indicate the volume (so the amount of stock) traded over whatever time period we have set (so remember our settings before, we are currently using a graph that is set in one minute time increments) and there are again several different types of volume graphs but we are going to use a basic one here because it really tells us everything we need to know at this level of analysis.

So a volume graph is, quite literally, a bar graph – the higher the bar, the more stock was traded in that time period and vice-versa. And, like the candles, you’ll see that the bars are also colour coded, but, and this is critical, they are coded according to the price change of the stock, not the volume change. So the colour of the bar goes green or red when the average price of the stock goes up or down, not the volume. A green bar which is smaller indicates lower volume but a higher price. A red bar which is bigger indicates higher volume but lower price. 

So it is the height of the bars which changes with volume, not the colour. Colour changes with price. Remember, this type of bar graph does not tell you how much the price of the stock went up or down in our set time period, it tells you how much the volume did.

So, now that we know how to read everything going on, let’s put it to the test shall we?

Let’s take a look at the time period of 15.44 (so 3.44pm) as indicated here:

[ATTACH=full]121889[/ATTACH]

As we can see it’s a green candle with both a top and a bottom wick so the price should have on average gone up in this period and had a high and a low that were both higher than the close and lower than the open, right?

Well:

[ATTACH=full]121890[/ATTACH]

Yes, actually! If we simply hover our mouse over this point we can see that we had an open of $30.23, a high of $30.27, a low of $30.21, a close of $30.24, and we on average went up by $0.02 or 0.06% from the previous minute.

We also had 1300 shares bought & sold in this time period, with a larger green bar telling us that there were MORE shares bought & sold at a HIGHER average price than the previous minute.

So now that you know how to read one of these charts, why is the data in it important?