By simply looking at a chart, it can seem potentially easy to make money. Yet many traders and investors do not watch price action in real-time. Rather, they only see a five-minute, hourly or daily chart in hindsight; they may even watch the charts in real-time, but as the period (bar) comes to an end much information is lost. Common charts, such as OHLC (open, high, low, close) and candlestick, lose information as the period being watched comes to an end. Traders who don't realize this can have a hard time implementing strategies they believe work on the summary data provided by charts, but may fail to work in live trading. (For a background, check out Analyzing Chart Patterns.)

IN PICTURES: Candlestick Charts

Lost Information
Charts provide summary data for a period, not a detailed breakdown of what happened during that period. When a bar is shown, what happened during the time the bar took place is lost. Only the open, high, low and close are left to tell of that time period. In hindsight, it may look like during that time period the price went straight from its open to close, when in fact there may have been many gyrating movements in between the open and close on that time frame.

The lost information may contain false breakouts, rapid back and forth movements or any combination of movements which are contained with the high, open, close and low of the bar.

In Figure 1, there is an hourly chart of BP (NYSE:BP). On the hourly chart, it may appear as if the market broke below 39.40 and proceeded to make a low at 39.21 before recovering in the next hour. Since we are looking at a bar, we assume the prices happen in a logical chronological order - in this case, open, high, low then close. The reality could be very different.

Figure 1. BP – Hourly, August 4, 2010
Source: Free Stock Charts

A trader running visual back tests may inadequately account for the fact that instead of moving through 39.40 and proceeding to 39.21 directly, the one-minute chart reveals that the price action was much more choppy, actually dropping below 39.40 (after moving back above or to 39.40) five times before making a low at 39.21. This is shown in Figure 2, where even price movement to 39.29 were much choppier than what appears when viewing an hourly chart, for example.

Figure 2. BP – 1 Minute, August 4, 2010
Source: Free Stock Charts

These small movements may not seem significant, but depending on the trading system and stops employed, one true breakout is very different from movement which fluctuates in a choppy fashion, generally retracing much of its prior movement before continuing. (For more, check out Tips For Creating Profitable Stock Charts.)

The Negative Effects
Much research and analysis is done on charts. Often, back testing is done using completed bars. But since there is a price movement within bars, several problems often develop, which affects actual live trading results:

  • A trader may be stopped out of a position continually and wonder why the strategy worked well on the backtest.
  • In real-time, the prices (entry and exit) expected may be hard to get. Prices quite often move a small amount and retrace. This makes getting the price wanted, at the time wanted, harder than it may appear on a longer-term chart.
  • When a position is a taken, there may be much fluctuation the trader does not expect because often completed bars make it appear a stock only moved in one direction. Often, when novice traders take on live traders, psychological factors such as fear or greed kick in because potentially rapid whipsawing price movements take them by surprise - this in itself can cause deviation from a set plan.
  • If a bar shows up movement (closed higher than it opened) it does not mean the low occurred before the high. Visually we want to see things in chronological order, and assume that the information we view is in this order. It is quite possible in the markets that what is visually logical did not occur that way in real-time.
  • When implementing trailing stops, using completed bars as a reference can be deceiving. An hourly bar may make price action look like it did not retrace, yet moving to a shorter time frame may show many retracements potentially triggering a trailing stop which may not appear logical on the longer time frame.

Getting More Information
From the example above, we can see that looking at more than one time frame can provide us a more complete picture of what has occurred over a period of time. Analyzing movements on all time frames can also help us better prepare our trading system for live trading in real-time market conditions.

If a trader trades in real-time, watching price movements all day, he or she may not have to look at multiple time frames to reconstruct the real-time price movement. Yet looking at multiple time frames can still provide valuable insights into support/resistance, trends or ranges not visible on one time but visible on another. Traders who cannot watch price movements in real-time should be aware of price characteristics that may not be evident in summary chart data.

Thus, it becomes important for traders to understand movements on all time frames so they can better implement their system on the time frame on which they enjoy trading. This is especially true if position stops are tight - be aware of short-term and longer term tendencies to better gauge where stops and profit targets should be placed.

Above all, avoid the idea that prices move in one direction even when a bar makes it appear so. Almost always, there is a back and forth movement to prices. While occasionally large moves do occur in one direction, most of the time this is not the case. (To learn more, see Day Trading Strategies For Beginners.)

Summary
When looking at charts in hindsight, information has been lost because (generally) all that is shown is the open, high, low and close. Information other than those four precise price levels is lost, and how the price moved within the bar's time frame can be significant. If traders are unaware of the tendencies of a given tradable, the system they expect to work (which was tested on completed bars) may not perform as expected in real-time. Therefore it is important to watch multiple time frames to understand that prices gyrate, and that shorter time frame retracements and movements can affect longer-term trading systems that were created by analyzing completed bars. (For more on this topic, check out our Technical Analysis Tutorial.)

Related Articles
  1. Forex Strategies

    Two Great Currencies To Profit From Oil Volatility

    U.S. dollar crosses with Canadian and Australian dollars offer easy access to crude oil trends due to their tight correlation with energy futures.
  2. Investing

    Redefining the Stop-Loss

    Using Stop-losses for trading doesn’t mean ‘losing money’, but instead think about the money you'll start saving once you learn how they work.
  3. Chart Advisor

    3 Ways to Trade the Rising Volatility

    With volatility increasing in the markets, many are turning to these three volatility-capturing exchange-traded products.
  4. Trading Strategies

    Stock Trading for Free: Now a Reality

    Believe it or not, you can now trade stocks and ETFs for free. Here's a look at providers offering commission-free trading.
  5. Chart Advisor

    Big Double Top Patterns On the Verge of Breaking

    These stocks have created big double top chart patterns, and are on the verge of breaking the patterns to the downside--a bearish signal.
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  7. Investing Basics

    A Primer On Investing In The Tech Industry

    The tech sector can provide fantastic returns for investors with a little know-how in the field.
  8. Chart Advisor

    Gold Struggles to Climb Higher and May Fall Soon

    Traders will be watching the price of gold over the coming weeks. We'll take a look at how a couple major moving averages are suggesting that the next move could be lower.
  9. Technical Indicators

    Use Market Volume Data to Determine a Bottom

    Market bottoms often carve out classic volume patterns that let observant traders make fast and accurate calls.
  10. Stock Analysis

    Fortinet: A Great Play on Cybersecurity

    Discover how a healthy product mix, large-business deal growth and the boom of the cybersecurity industry are all driving Fortinet profits.
RELATED TERMS
  1. Middle Market

    Definition of middle market
  2. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
  3. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...
  4. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  5. Indicator

    Indicators are statistics used to measure current conditions ...
  6. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
RELATED FAQS
  1. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  2. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  3. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  4. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  5. How can a company execute a tax-free spin-off?

    The two commonly used methods for doing a tax-free spinoff are either to distribute shares of the spinoff company to existing ... Read Full Answer >>
  6. How are American Depository Receipts (ADRs) priced?

    The price of an American depositary receipt (ADR) is determined by the bank or other financial institution that issues it. ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!