Chapter 1. Introduction to Line-break charts
Three-line break charts originated in Japan during the 19th century and it is said that this technique was used in rice trading. This is another old form of charting originating from Japan along with the likes of Renko, Kagi and Heikin-ashi charts. Line-break chart was introduced to the western world by Steve Nison in his book Beyond Candlesticks.
These are known as Three Line break charts because of the default reversal value of three that is typically used. But these charts can be plotted using any other reversal value too. Hence, the appropriate generic name would be Line-break charts. They are also known as three-step new price, three-step reversal charts, Box reversal charts, Line reversal charts or Three box reversal charts.
Three line-break is a widely used name so we will stick to that. They are in widespread use in the Far East but not so much prevalent elsewhere. But this charting method is available in most of the charting platforms. Line-break chart belongs to the One-dimensional charting family such as P&F, Renko and Kagi. These time-independent charts plot only price and new price action gets captured in the chart only when there is price move which meets a certain criterion. This genre of charts eliminate noise to a large extent and plot charts with easily readable patterns.
P&F charts plot prices vertically based on a user-defined box-value and reversal value. They are more dynamic in nature and show swing price patterns. Renko charts are plotted diagonally and the user has to define only the brick-value while plotting them. They also divide price moves into number of bricks and show the swing patterns. Line break charts need only one variable to construct the chart which is known as the reversal value.
Have a look at image below. These are the closing prices of a stock.
If we connect these closing price and draw the line, it becomes a line chart.
Instead of connecting the dots and drawing the line chart, we can connect the two closing price and draw the box as shown below.
This way, we can draw a box of all closing prices.
Let’s fill them with Green and Red color. If price is bullish, color of the line is bullish and if price is bearish color of the line is bearish.
This way, we can see price trending using boxes instead if lines.
See the price shown in the below chart.
If you notice, there are the prices within the previous box. If we remove them from the charts, it will remove the noise from the chart and capture the price information that is relevant.
Let’s remove those dots from the chart and connect the boxes and that becomes Line-break chart.
Each box in the above chart is known as Lines, and this is how Line break charts are constructed.
The reversal value in above line-break chart is one. Meaning, we draw the bearish reversal line if price falls below the low of previous line and bullish reversal line if price goes above the high of previous line. Usually, reversal value of three is considered as the default setting which is why it is popularly known as the Three-Line Break charting method.
Be familiar with word ‘line’ now. In the entire blog series Line or lines mean these boxes connecting two prices. The name is unfortunate in this context and can be confusing initially but we must use it because that is what they are traditionally called. But not to worry, you will be comfortable with these nomenclatures once you understand their usefulness and unique properties.
Line Break charts display a series of vertical boxes (lines) that are based on changes in price. As explained above, normally closing prices are used for plotting these charts. It is possible to use high and low prices to construct the Line-break chart, but we will discuss that later.
Rules for plotting three-line break charts are as follows:
- If three consecutive bullish lines are formed, then a new bearish line is drawn only if price fall below the lowest point of the last three bullish lines.
- If three consecutive bearish lines are formed, then a new bullish line is drawn only if price rise above the highest point of the last three bearish lines.
Let me explain the construction of Three-line break charts step by step.
Construction of Three-line break chart
Below table is a list of prices used for construction of Three-line break chart
First thing to do is to decide whether to begin with bullish line or bearish line. A line cannot be plotted with single price hence second price is required to decide the same. The 2nd price in the table is 101. Hence bullish line is plotted from 100 to 101. See below Figure.
Third price is 104 which is higher than previous lines. So second bullish line is plotted as shown below.
High price of current line is 104 and low is 101. The 4th price is 105 hence one more bullish line gets plotted.
High price of current line is 105 and low price is 104. Reversal line in Three-line reversal chart is plotted when price breaches extreme price of previous three lines. Bearish reversal line gets plotted when price goes below the low of last three lines. Three line low in this chart is 100. Bearish reversal line will not get plotted unless the price falls below 100.
The 5th price is 108 and this will result in another bullish line as shown below.
High price of the current line is 108 and low price is 105. Reversal price now is 101 being the lowest price of last three lines. The 6th price is 112 hence another bullish line is plotted.
Reversal line now stands at 104 being the lowest price of last three lines. The 7th price is 108 hence bullish line cannot be drawn. As the price is not below 104, a reversal cannot be plotted either. Hence the chart remains unchanged.
The 8th price is 103 which is below reversal price. Hence bearish line is to be drawn as shown below.
High price of current line is 108 and low price is 103. Bearish line will get plotted if price keep going down below 103. Reversal price to plot bullish line is 112 being highest price of last three lines.
Remaining prices can be plotted with the same rules. Below Table shows the High price, Low price and Reversal price against each price.
Below figure shows the final Three line break chart of construction exercise.
Hope you got the idea about how three-line break charts are constructed. Technique is that, the trend is bullish unless price falls below the lowest point of last three lines, and bearish unless it goes above last three lines on the Line-break chart.
How about using other reversal values? While technique of using them will be discussed later, it is possible to plot charts with other reversal values using same table of price.
Table below shows prices for construction of Line-break chart using other reversal values.
Five-Line break chart
If reversal value of Five is used instead of Three, the chart would be called as a Five-Line reversal chart.
Table below shows the High price, Low price and Reversal price of every line against each price.
Below Figure shows the final construction of Five line break chart from the above table.
Four-Line break chart
Below is a Table showing the High, Low and Reversal price of every line against each price.
Below Figure shows the final construction of Four-line break chart as per the above table.
Two-Line break chart
Table below shows the High price, Low-price and Reversal price of every line against each price.
Figure below shows the final construction of Two-line break chart from the above table.
So, you must have got the idea about how Line-break charts are plotting using different reversal values.
So, Line-break chart move only when price trend or reverse by a certain criterion. It condenses the price action of price-time charts and displays only trending moves. Below is the example of a Three-line break chart. Blue coloured lines are bullish lines and Red lines are bearish lines.
These charts are visually very appealing and captures the trending move in a visually appealing format. By constructing a price chart in this manner one can easily classify the price between bullish and bearish lines.
The reversal price values are also known in advance. If you are following three-line break reversal chart, lowest price of last three lines is a bearish reversal level and highest price of last three lines is a bullish reversal level.
This can be a helpful information from a trading perspective. The user thus knows where a stop can be kept.
How they are different from other Noiseless charts?
As mentioned earlier, P&F, Renko and Kagi are other one-dimensional charts. P&F charts are plotted vertically, and price move captured via fixed boxes. We need continuation and reversal value to plot them. Renko charts are plotted diagonally and price action is plotted as bricks based on the chosen brick value. Reversal value is also required to plot them. Kagi charts are also plotted vertically but need only reversal value to plot. I have a different take on them and will write about them separately.
Line-break charts need reversal value, and the move is not divided into fixed length of boxes. That is why the length of the line would vary as per the price trend. Prices are plotted as per the move (without capturing them into fixed length brick or box) is an important property of the Line-break chart.
So, each of these methods have some unique properties to offer. I believe in exploring them and talking about possibilities of trading systems using them. The biggest advantage of noiseless charts is that – they are objective in nature and simple to follow once understood. Indeed, they can help in removing noise from the charts and between the ears.
Understanding Line-break charts
So, now you know how Line-break charts are constructed. Think, what does a Line in a Line-break chart represent? It is a difference between two closing prices. A body of a candle in candlestick chat is a difference between open and close. In Line-break charts, body is a Line. Line of a Line-break chart is a difference between current closing price and a previous closing price. There are no shadows. Do we have any charting facility where this feature is available? No! It is a unique property of Line-break charts.
At the end of the day when we discuss market or stock, how the rate of change is described normally? We say a stock went up or down by X points. How is it calculated? By comparing it to previous closing price – right?
When a stock rises or falls significantly, the length of the line will be big. If stock went up or down by a smaller value – length of line will be small. Have a look at the charts below.
More on Length of lines later. Each Line represent two prices: Current price and previous price. Let us call it the high price and the low price of Line.
When Line is bullish: Current closing price becomes high of the Line and previous closing price becomes Low price of the Line.
When Line is bearish: Current closing price becomes Low of the Line and previous closing price becomes High price of the Line.
The combination of Lines helps us in analysing the price pattern.
Have a look at below Line chart of Tata steel.
Observe the price patterns in circle A, B, C and D marked on the chart. Pattern A captures a down trend but volatile price action. Pattern B is a sideways and narrow range market condition. Pattern C captures an but there are some small corrections in between. Pattern D is a volatile market in an uptrend.
Observe the same patterns in Line-break format below.
Same price formations are clearly identifiable in the Line-break charts. Trends are clear and noise-free.
Advantage is - number of lines can be calculated in the trend making the chart objective and give us opportunity to design patterns and frame rules to trade.
Series of lines in Line-break charts shows a strong trend.
So, Line-break charts display clear trends. They are objective in nature and patterns can be designed using combination of lines. We will discuss more about that in the chapter on Patterns.
One-dimensional charts are also known as a Time-less charts. They don’t consider time while plotting the charts but time is and volume can be plotted on these charts. Price and time are fundamentally different.
Time passes by while price trends. By plotting charts based only on price, we are opting not to plot patterns when price did not move.
Price moves = Trend
Time passed without price moving = Noise
Hence, I like to call them Noiseless charts rather than Timeless. When we plot Noiseless charts, we prefer to look at price moves irrespective of time.
But we plot them on Daily, weekly, monthly, One, min, hourly etc. What is this then? It is a data frequency. For example, data frequency is weekly when the chart is plotted on weekly timeframe. Meaning, we will consider price after last day of the week. What happens in between can change by end of the week. Same way, we consider price after fifteen minutes when chart is plotted on fifteen-minute timeframe. The price being considered is calculated for plotting Line-break charts.
I prefer using Daily timeframe charts for EOD charts than other timeframes because of this reason. We will discuss timeframe and other things for intra-day in the later chapters after discussing few important concepts of Line-break charts.
There will be more of continuation Lines on the Line break charts because there is no criteria for continuation lines. It may seem logical that more bullish lines would be printed in an uptrend and bearish lines in a downtrend. This however needs be tested to confirm if there is any such correlation with the state of the trend.
Below Table shows yearly proportion of bullish and bearish line appearance in daily Three-line break chart of Nifty 50 during 1st January 2005 to 31st December 2019.
It is evident that the occurrence of bullish & bearish lines are in line with the market undertone during the year. Bullish lines dominate in bullish scenarios and vice-versa. They are close to equilibrium in consolidation phase.
That means, if focus is more on bullish patterns when bullish lines are dominating could be a sensible strategy. Focus can be shifted to adopting bearish strategies when bearish lines starts dominating.
Let us explore this. The objectivity of Line-break charts makes them highly effective from Data testing perspective. I am taking the advantage of that feature and opting the Data testing approach while discussing the concepts. Let's briefly discuss conventional analysis on Line-break charts in chapter 2.
Click here to read chapter 2.