CONSTRUCTION OF THE DAILY BAR CHART

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CONSTRUCTION OF THE DAILY BAR CHART

The construction of the daily bar chart is extremely simple. The bar chart is both a price and a time chart. The vertical axis (the y axis) shows a scale representing the price of the contract. The horizontal axis (the x axis) records the passage of time. Dates are marked along the bottom of the chart. All the user has to do is plot a vertical bar in the appropriate day from the day’s high to the day’s low (called the range). Place a horizontal tic to the right of the vertical bar identifying the daily closing price. (See Figure 3.7.)

The reason for placing the tic to the right of the bar is to distinguish it from the opening price, which chartists record to the left of the bar. Once that day’s activity has been plotted, the user moves one day to the right to plot the

next day’s action. Most chart services use five day weeks. Weekends are not shown on the chart. Whenever an exchange is closed during the trading week, that day’s space is left blank. The bars along the bottom of the chart measure volume. (See Figure 3.7.)

Figure 3.6 Longer view of Intel using two different price scales. The chart to the left shows the traditional arithmetic scale. The chart on the right shows a logarithmic scale. Notice that the three year up trendline worked better on the log chart.

VOLUME

Another piece of important information should be included on the bar chart volume. Volume represents the total amount of trading activity in that market for that day. It is the total number of futures contracts traded during the day or the number of common stock shares that change hands on a given day in the stock market. The volume is recorded by a vertical bar at the bottom of the chart under that day’s price bar. A higher volume bar means the volume was heavier for that day. A smaller bar represents lighter volume. A vertical scale along the bottom of the chart is provided to help plot the data, as shown in Figure 3.7.

Figure 3.7 A closer look at the Intel daily bar chart. Each bar measures the day’s price range. The opening price is marked by the small tic to the left of each bar. The closing tic is to the right. The bars along the bottom measure each day’s volume.

FUTURES OPEN INTEREST

Open interest is the total number of outstanding futures contracts that are held by market participants at the end of the day. Open interest is the number of outstanding contracts held by the longs or the shorts, not the total of both. Remember, because we’re dealing with futures contracts, for every long there must also be a short. Therefore, we only have to know the totals on one side. Open interest is marked on the chart with a solid line along the bottom, usually just above the volume but below the price. (See Figure 3.8.)

Figure 3.8 A daily line chart of a Treasury Bond futures contract The vertical bars along the bottom measure the total daily volume. The solid line along the middle represents the total outstanding open interest for the Treasury Bond futures market.

Total Versus Individual Volume and Open Interest Numbers in Futures

Futures chart services, along with most futures technicians, use only the total volume and open interest figures. Although figures are available for each individual delivery month, the total figures for each commodity market are the ones that are used for forecasting purposes. There is a good reason for this.

In the early stages of a futures contract’s life, volume and open interest are usually quite small. The figures build up as the contract reaches maturity. In the last couple of months before expiration, however, the numbers begin to drop again. Obviously, traders have to liquidate open positions as the contract approaches expiration. Therefore, the increase in the numbers in the first few months of life and the decline near the end of trading have nothing to do with market direction and are just a function of the limited life feature of a commodity futures contract. To provide the necessary continuity in volume and open interest numbers, and to give them forecasting value, the total numbers are generally used. (Stock charts plot total volume figures, but do not include open interest.)

Futures volume and open interest numbers are reported a day late. Therefore, the chartist must be content with a day’s lag in obtaining and interpreting the figures. The numbers are usually reported during the following day’s trading hours, but too late for publication in the day’s financial newspapers. Estimated volume figures are available, however, after the markets close and are included in the following morning’s paper. Estimated volume numbers are just that, but they do at least give the futures technician some idea of whether trading activity was heavier or lighter the previous day. In the morning paper, therefore, what the reader gets is the last day’s futures prices along with an estimated volume figure. Official volume and open interest numbers, however, are given for the day before. Stock chartists don’t have that problem. Volume totals for stocks are immediately available.

The Value of Individual Volume and Open Interest Numbers in Futures

The individual open interest numbers in futures do provide valuable information. They tell us which contracts are the most liquid for trading purposes. As a general rule, trading activity should be limited to those delivery months with the highest open interest. Months with low open interest numbers should be avoided. As the term implies, higher open interest means that there is more interest in certain delivery months.

WEEKLY AND MONTHLY BAR CHARTS

We’ve focused so far on the daily bar chart. However, be aware that a bar chart can be constructed for any time period. The intraday bar chart measures the high, low, and last prices for periods as short as five minutes. The average daily bar chart covers from six to nine months of price action. For longer range trend analysis, however, weekly and monthly bar charts must be used. The value of using these longer range charts is covered in Chapter 8. But the method of constructing and updating the charts is essentially the same. (See Figures 3.9 and 3.10.)

On the weekly chart, one bar represents the price activity for the entire week. On the monthly chart, each bar shows the entire month’s price action. Obviously, weekly and monthly charts compress the price action to allow for much longer range trend analysis. A weekly chart can go back as much as five years and a monthly chart up to 20 years. It’s a simple technique that helps the chartist study the markets from a longer range perspective—a valuable perspective that is often lost by relying solely on daily charts.

Figure 3.9 A weekly bar chart of the U.S. Dollar Index. Each bar represents one week’s price data. By compressing the price data, the weekly chart allows for chart analysis of longer range price trends, usually in the vicinity of five years.

Figure 3.10 A monthly bar chart of the U.S. Dollar Index. Each bar represents one month’s price data. By compressing the data even further, the monthly chart allows chart analysis for periods as long as twenty years.

CONCLUSION

Now that we know how to plot a bar chart, and having introduced the three basic sources of information—price, volume, and open interest—we’re ready to look at how that data is interpreted. Remember that the chart only records the data. In itself, it has little value. It’s much like a paint brush and canvas. By themselves, they have no value. In the hands of a talented artist, however, they can help create beautiful images. Perhaps an even better comparison is a scalpel. In the hands of a gifted surgeon, it can help save lives. In the hands of most of us, however, a scalpel is not only useless, but might even be dangerous. A chart can become an extremely useful tool in the art or skill of market forecasting once the rules are understood. Let’s begin the process. In the next chapter, we’ll look at some of the basic concepts of trend and what I consider to be the building blocks of chart analysis.