James Chen, CMT is an expert trader, investment adviser, and global market strategist. He has authored books on technical analysis and foreign exchange trading published by John Wiley and Sons and served as a guest expert on CNBC, BloombergTV, Forbes, and Reuters among other financial media." data-inline-tooltip="true">James Chen
*

James Chen, CMT is an expert trader, investment adviser, and global market strategist. He has authored books on technical analysis and foreign exchange trading published by John Wiley and Sons and served as a guest expert on CNBC, BloombergTV, Forbes, and Reuters among other financial media.

You are watching: Which of the following best describes the purpose of a histogram?


*

Gordon Scott has been an active investor and technical analyst of securities, futures, forex, and penny stocks for 20+ years. He is a member of the brickandmortarphilly.com Financial Review Board and the co-author of Investing to Win. Gordon is a Chartered Market Technician (CMT). He is also a member of CMT Association.

What Is a Histogram?

A histogram is a graphical representation that organizes a group of data points into user-specified ranges. Similar in appearance to a bar graph, the histogram condenses a data series into an easily interpreted visual by taking many data points and grouping them into logical ranges or bins.


A histogram is a bar graph-like representation of data that buckets a range of outcomes into columns along the x-axis.The y-axis represents the number count or percentage of occurrences in the data for each column and can be used to visualize data distributions.In trading, the MACD histogram is used by technical analysts to indicate changes in momentum.

How Histograms Work

Histograms are commonly used in statistics to demonstrate how many of a certain type of variable occurs within a specific range. For example, a census focused on the demography of a country may use a histogram to show how many peopleare between the ages of 0 - 10, 11 - 20, 21 - 30, 31 - 40, 41 - 50, etc. This histogram would look similar to the example below.


Histograms can be customized in several ways by the analyst. The first is to change the interval between buckets. In the above example, there are 5 buckets with an interval of ten. This could be changed, for example, to 10 buckets with an interval of 5 instead.


The other consideration is how to define the y-axis. The most basic label is to use the frequency of occurrences observed in the data, but one could also use percentage of total or density instead.


*

Both histograms and bar charts provide a visual display using columns, and people often use the terms interchangeably. More technically, a histogram represents the frequency distribution of variables in a data set. On the other hand, a bar graph typically represents a graphical comparison of discrete or categorical variables.


Example: The MACD Histogram

Technical traders may be familiar with the moving average convergence divergence (MACD) histogram, a popular technical indicator that illustrates the difference between the MACD line and the signal line.


For example, if there is a $5 difference between the two lines, the MACD histogram graphically represents this difference. The MACD histogram is plotted on a chart to make it easy for a trader to determine a specific security’s momentum.


A histogram bar is positive when the MACD line is above the signal line, and negative when the MACD line is below the signal line. An increasing MACD histogram indicates an increase in upward momentum, while a decreasing histogram is used to signal downward momentum.


*

Trading with the MACD Histogram

Traders often overlook the MACD histogram when using this indicator to make trading decisions. A weakness of using the MACD indicator in its traditional sense, when the MACD line crosses over the signal line, is that the trading signal lags price. Because the two lines are moving averages, they do not cross until a price move has already occurred. This means that traders forego a portion of this initialmove.


The MACD histogram helps to alleviate this problem by generating earlier entry signals. Traders can track the length of the histogram bars as they move away from the zero line. The indicator generates a trading signal when a histogram bar is shorter in length than the preceding bar. Once the smaller histogram bar completes, traders open a position in the direction of the histogram’s decline.

See more: Another Name For Needs Analysis Is ____., Needs Analysis Synonyms With Definition


Other technical indicators should be used in conjunction with the MACD histogram to increase the signal’s reliability. Moreover, traders should place a stop-loss order to close the trade if the security’s price does not move as anticipated.