How to Use Heikin-Ashi to Spot Trading Opportunities?

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.

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.

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.

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.

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.

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.

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.

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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