When you're trading stocks using Japanese candlesticks and a bunch of indicators, it can sometimes be hard to determine the overall trend of a particular stock. The chart gets messy and difficult to read.
This is where the method of 3-line break charting can help.
In order to see why three-line break is sometimes useful, let's take a look at a recent chart of Netflix.
There are a lot of ups and downs in this chart, making it sometimes difficult to know what the general trend is for the stock.
Compare this to the three-line break chart.
Not only are there no gaps in this chart. But the general trend during each time period is also clear.
A 3-line break chart draws lines based only on closing prices. So no information about movements within a time period are displayed. For example, this type of daily chart will not show intra-day movements.
In addition, not every unit of the time period will be displayed. So a daily chart will not have a line for every single day.
Instead, the chart only draws a line when a certain relationship exists between the new closing price and the top or bottom of the previous three lines.
Here is the relationship:
1. When the new closing price is above the top of the previous three lines, a new line is drawn connecting the top of the previous three lines with the new close.
2. When the new closing price is below the bottom of the previous three lines, a new line is drawn connecting the bottom of the previous three lines with the new close.
3. When the new closing price is neither above the top of the previous three lines nor below the bottom of the previous three lines, no new line is drawn.
This might seem complicated. But essentially, what this does is create a chart that only shows significant uptrends and downtrends, filtering out all of the noise created by insignificant ones.
One very simple way to trade using this type of chart is to buy or sell whenever the first line of a reversal is finished printing.
For example, here's that same Netflix chart again with some entry and exit points labeled.
Since most stocks tend to trend in one direction or the other most of the time, this can be a very profitable strategy.
However, it can also sometimes lead to whipsaws in a ranging market.
So one other strategy you can use is to combine a 3-line break chart with moving averages, trendlines, or other techniques of technical analysis.
Here is the same chart with some moving averages, trendlines, and lines of support and resistance.
Adding these extra indicators cuts down on the number of false signals and allows this type of chart to be even more powerful.
Traditional candlestick charts can sometimes be messy and confusing. But using three-line charts can allow you to see trends more clearly.
When combined with a few other techniques, it can be a a powerful tool to add to your trading arsenal.