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A stock chart is simply a graph that shows price changes over time. In this book, I use two types. The first is a chart that shows the price of the underlying instrument, like stock, future, or index, over a period of time. The second is a payoff chart, or risk graph, and shows the potential risks and rewards of an options strategy. It is covered in more detail in later chapters. For now, let's discuss the basics of stock charting.

The simplest chart type is a line chart. For instance, it's easy to plot a line chart in a spreadsheet using data like date and price. Figure 1.3 shows a daily chart of hypothetical oil prices over twelve months. The line connects the twelve points where price and date intersect on the graph. It starts at $50 per barrel in January and ends at $53 in December.

Figure 1.3 Line Chart of Monthly Oil Prices

Traders plot charts for instruments like stocks, interest rates, or commodities to see trends over time. Obviously, few create the charts by hand or in spreadsheets. Charts are readily available on financial websites like StockCharts.com or Google Finance and also through online brokerage firms.

A second, more widely used chart is the open-high-low-close, or OHLC, chart. While the line chart is plotted using just the closing price, an OHLC chart includes bars that contain four pieces of price information.

Figure 1.4 shows an individual bar of an open-high-low-close chart. The small horizontal lines are the opening and closing prices. In this example, the stock opened at one price and closed at a lower price. The length of the vertical line represents the trading range of the day, because the top of the bar is the highest price and the bottom is the lowest.

Figure 1.4 OHLC Bar

Like the price chart, the horizontal axis (or bottom) of the OHLC chart represents time, such as days, weeks, or months. The vertical axis (or side) indicates price per unit, such as shares or contracts. Figure 1.5 shows an OHLC chart for a three-month period ended 11/30/2015. The time frame is plotted across the horizontal axis, and the change in price is depicted along the vertical axis.

Figure 1.5 Daily Chart of S&P 500 Index (8/31/2015–11/30/2015)

Notice that the OHLC bars are not all the same length. Longer ones suggest greater distances between highs and lows, and therefore increasing volatility in the security. Shorter ones suggest narrow trading, smaller daily moves, and periods of lower volatility or narrow trading ranges.

The time frame of an OHLC chart can be changed to weekly or monthly. If so, each bar represents the change over one week or one month. Short-term traders sometimes watch intraday bar charts at five-, ten-, or fifteen-minute intervals. Most of the examples throughout this book use daily OHLC charts.

More advanced charting tools are covered in Appendix B. If you have no previous experience with charting, take some time to learn how to identify areas of support and resistance with indicators like trend lines and moving averages. In addition, because the focus of later chapters is on options strategies, volatility studies are also useful. Those are covered in Appendix B as well.