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How to Use Heikin-Ashi to Spot Trading Opportunities?

Heikin-Ashi charts filter out market noise and help traders identify the trend and its strength as well as when the trend is ripe for a reversal.

Disclaimer: This article is an educational guide to CFD trading and the financial markets and should not be considered as advice. Trading CFDs is high risk. Always ensure you understand the potential risks and rewards associated with trading before you trade.

 

The timely identification of price trends and their continuation or reversal is an important part of any trading strategy. The Japanese Heikin-Ashi charts use average price data to filter out market noise, making it easier for traders to identify trading opportunities. The charts help traders decide whether to hold onto a trade or get ready to close a position due to a possible trend reversal, enabling them to avoid losses or lock-in more profits.

Did you know?

Heikin-Ashi charts are typically used by day traders and swing traders.

1. Understanding Heikin-Ashi

Developed by Munehisa Homma in the 1700s, Heikin-Ashi literally translates to “average bar”. It smooths out price movements to form candlestick charts of average prices. The technique uses the two-period moving average, rather than the open, high, low, and close prices that are used in traditional candlestick charts. This makes it easier for traders to spot trends and reversals.

Did you know?

Heikin-Ashi charts have gained popularity because they give fewer false signals than using most other indicators with candlestick charts.

2. The Heikin-Ashi Formula

The Heikin-Ashi formula uses the open-close data from the previous period and the open-high-low-close data from the current period.

  • The Heikin-Ashi Open (or HA Open) is always set to the midpoint of the body of the previous bar as it is the average of the opening and closing prices of the previous bar.
    (Open price of previous bar + Close of the previous bar) / 2
  • The HA Close is the average price of the opening, closing, high and low prices of the current bar.
    (Open + High + Low + Close) / 4
  • The HA High is the highest value of three prices – Current High, HA Open, and HA Close.
  • The HA Low is the lowest value of three prices – Current Low, HA Open, and HA Close.

3. Things to Remember

  • There are no gaps on a Heikin-Ashi chart as the current candle is calculated using information from the previous candle.
  • Each Heikin-Ashi bar starts from the middle of the previous bar and not from the level where the previous candle has closed.
  • This chart differs from the traditional candlestick chart by smoothing directional moves with several successive bars of the same colour. Consecutive coloured candles facilitate the easy identification and interpretation of previous price movements and current trends.
  • The charts reflect the strength of a trend and its continuation or reversal.
  • The chart can be used for trading all types of instruments.
Strategy Tip

Prices on the Heikin-Ashi chart are often untradable, as they are not the actual price of the instrument. Experienced traders typically use this chart, along with traditional candlestick charts to place trades and technical indicators to identify entry and exit points. The most popular indicators used are Bollinger Bands and RSI.

4. Reading Heikin-Ashi Charts

A. Identifying a Trend

Many consecutive green candlesticks indicate an uptrend, which means traders with long positions can continue riding the trend, while those with short positions should exit. Similarly, several red candles appearing together signify a downtrend, which means it’s time for traders going long to close their positions.

In Heikin-Ashi charts, the candles remain red during a downtrend and green during an uptrend, unlike the regular candlestick charts, where the candles change colour even in a trending market.

Strategy Tip

Experienced traders typically use trailing stops to derive the maximum benefits from a trending market.

The appearance of green candles without lower wicks indicates a strong uptrend, while that of red candles with no upper wicks is indicative of a strong downtrend. When this happens, seasoned traders hold onto their long or short positions to maximise gains.

B. Identifying a Trend Reversal

The appearance of candles with small bodies and long wicks indicates a trend reversal. During a downtrend, the appearance of red candles with very long lower wicks indicates buying pressure. Although the downtrend may continue, the bulls are able to ensure the closing price is much higher than the session’s low. The body of the red candles becoming smaller is indicative of bulls gaining strength, suggesting a possible trend reversal.

Similarly, when green candles with increasingly smaller bodies and longer upper wicks appear, it means the bears have entered the market and are gaining strength. This suggests a potential reversal from the current uptrend.

Strategy Tip

Seasoned traders with higher risk tolerance wait for such reversals to enter long or short positions. While entering a trend early maximises the profit potential, it is risky. Traders with lower risk tolerance can wait for the Heikin-Ashi candles to change colour before entering a position.

C. Identifying Indecision in the Market

The appearance of candles with small bodies and long upper and lower wicks indicates indecision, irrespective of the colour of the candle. This could simply be a pause before the market continues trending in the same direction.

5. Trading with the Heikin-Ashi Triangles

Three types of triangles are common in Heikin-Ashi charts. Experienced traders look out for descending, ascending and symmetrical triangles. If the candles form an ascending or symmetrical triangle, and the price action breaks the upper line of the triangle, it indicates that the uptrend is likely to continue. If, on the other hand, the price action breaks the lower line of the triangle, it means a bearish trend could begin.

In a bear market, the Heikin-Ashi charts form descending triangles. When the price action breaks the lower line of the triangle, the downtrend can be expected to continue. When the price action breaks the upper line, a new bullish move is anticipated.

4. Reading Heikin-Ashi Charts

A. Identifying a Trend

Many consecutive green candlesticks indicate an uptrend, which means traders with long positions can continue riding the trend, while those with short positions should exit. Similarly, several red candles appearing together signify a downtrend, which means it’s time for traders going long to close their positions.

In Heikin-Ashi charts, the candles remain red during a downtrend and green during an uptrend, unlike the regular candlestick charts, where the candles change colour even in a trending market.

Strategy Tip

Experienced traders typically use trailing stops to derive the maximum benefits from a trending market.

The appearance of green candles without lower wicks indicates a strong uptrend, while that of red candles with no upper wicks is indicative of a strong downtrend. When this happens, seasoned traders hold onto their long or short positions to maximise gains.

B. Identifying a Trend Reversal

The appearance of candles with small bodies and long wicks indicates a trend reversal. During a downtrend, the appearance of red candles with very long lower wicks indicates buying pressure. Although the downtrend may continue, the bulls are able to ensure the closing price is much higher than the session’s low. The body of the red candles becoming smaller is indicative of bulls gaining strength, suggesting a possible trend reversal.

Similarly, when green candles with increasingly smaller bodies and longer upper wicks appear, it means the bears have entered the market and are gaining strength. This suggests a potential reversal from the current uptrend.

Strategy Tip

Seasoned traders with higher risk tolerance wait for such reversals to enter long or short positions. While entering a trend early maximises the profit potential, it is risky. Traders with lower risk tolerance can wait for the Heikin-Ashi candles to change colour before entering a position.

C. Identifying Indecision in the Market

The appearance of candles with small bodies and long upper and lower wicks indicates indecision, irrespective of the colour of the candle. This could simply be a pause before the market continues trending in the same direction.

5. Trading with the Heikin-Ashi Triangles

Three types of triangles are common in Heikin-Ashi charts. Experienced traders look out for descending, ascending and symmetrical triangles. If the candles form an ascending or symmetrical triangle, and the price action breaks the upper line of the triangle, it indicates that the uptrend is likely to continue. If, on the other hand, the price action breaks the lower line of the triangle, it means a bearish trend could begin.

In a bear market, the Heikin-Ashi charts form descending triangles. When the price action breaks the lower line of the triangle, the downtrend can be expected to continue. When the price action breaks the upper line, a new bullish move is anticipated.

Key Takeaways

  • Heikin-Ashi smoothens out price fluctuations and makes it easier to identify trends and reversals. These charts cannot identify exact entry and exit points or stop loss levels, which is why seasoned traders use them in combination with technical indicators used on traditional candlestick charts.
  • Many green candlesticks appearing together indicate an uptrend, while any red candles signify a downtrend.
  • Green candles without lower wicks indicate a strong uptrend, while red candles with no upper wicks indicate a strong downtrend.
  • Candles with small bodies and long wicks indicate a trend reversal.
  • Candles with small bodies and long upper and lower wicks indicate indecision among traders.

 

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