Heikin-Ashi Candlestick

Heikin-Ashi, also sometimes spelled Heiken-Ashi, means "average bar" in Japanese. The Heikin-Ashi technique can be used in conjunction with candlestick charts when trading securities to spot market trends and predict future prices. It's useful for making candlestick charts more readable and trends easier to analyze. For example, traders can use Heikin-Ashi charts to know when to stay in trades while a trend persists but get out when the trend pauses or reverses. Most profits are generated when markets are trending, so predicting trends correctly is necessary.

In Japanese, Heikin-Ashi means "average bar". It is a popular technique used to enhance candlestick charts. This enhancement is usually done by smoothing out price data which makes charts more readable. Such an improved readability makes it easier to analyse trends and predict prices.

Also, traders use Heikin-Ashi charts to decide when to stay in trades during persistent trends and when to exit as trends pause or reverse. This approach maximises profits, as traders can make the most of their gains during strong market trends by using these charts.

Let’s understand the Heikin-Ashi candle patterns in detail, learn their implementation, and see what other indicators you can use alongside these charts to enhance trading decisions.

Heikin-Ashi candles are calculated differently from traditional candlesticks, which simply use the open, high, low, and close prices of each period. Whereas, the Heikin-Ashi method averages these prices and uses a modified calculation method. Let’s see in easy steps how you can calculate the values of Heikin-Ashi candles:

Step I: Calculate the close price

• The closing price for a Heikin-Ashi candlestick is one-fourth of the average of the open, high, low, and close prices of the current period.
• Formula: (Open + High + Low + Close)/4
• This represents the average price of the current bar.

Step II: Calculate the open price

• The opening price for a Heikin-Ashi candlestick is half of the average of the open and close prices of the previous period.
• Formula: (Opening of previous bar + Closing of previous bar)/2
• This represents the mid-point of the previous bar.

Step III: High price calculation

• The high price for a Heikin-Ashi candlestick is the highest value among the high, open, and close prices of the current period.
• Formula: Max[High, Open, Close]

Step IV: Low price calculation:

• The low price for a Heikin-Ashi candlestick is the lowest value among the low, open, and close prices of the current period.
• Formula: Min[Low, Open, Close]

For more clarity, let’s study a hypothetical example:

• Say you have the following data for a particular period:
  • Open: 100
  • High: 110
  • Low: 95
  • Close: 105
  • The previous period's opening was 98 and closing was 103

Now, let’s calculate the different values using the Heikin-Ashi formulas:

• Close: (100 + 110 + 95 + 105 )/4 = 102.5
• Open: (98 + 103 )/2 = 100.5
• High: Max(110, 102.5, 100.5) = 110
• Low: Low(95, 102.5, 100.5) = 95

Hence, in this case, the Heikin-Ashi candles for this period would have:

• Open: 100.5
• High: 110
• Low: 95
• Close: 102.5

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Heikin-Ashi charts are built similarly to regular candlestick charts, but the method for calculating each candlestick is different (as discussed above). This causes Heikin-Ashi candle patterns to look smoother than regular candlestick charts because they average the price data. Now, let’s see how you can construct a chart:

• Choose the time interval for the chart, such as daily, hourly, or five-minute intervals.
• When it comes to candlestick colours:
  • “Up days” are represented by empty (white or green) candles. These indicate rising prices.
  • “Down days” are represented by filled (red or black) candles. These indicate falling prices.
• In a downtrend, Heikin-Ashi candles stay red consistently, whereas in an uptrend, these candles stay green.

It must be noted that on a regular candlestick chart, the current price of the asset matches the closing price of the most recent candlestick. On the other hand, on a Heikin-Ashi chart, the current price may not match the actual market price because it represents an average. Due to this averaging, many charting platforms show two prices on the Y-axis:

• One for the Heikin-Ashi calculation
  and
• One for the actual current market price of the asset

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Heikin-Ashi charts can be used in any market. It is for this reason most charting platforms offer Heikin-Ashi charts as an option. These charts mainly generate five types of signals to identify trends and trading opportunities:

• Strong uptrend (hollow/ green candles with no lower shadows)
  • These candles indicate a strong upward movement.
  • In this situation, you can continue holding your long (buy) positions to maximise profits.
• Uptrend (hollow/ green candles)
  • These candles show an upward trend, even if they have lower shadows.
  • Consider adding to your long positions (buy more) and exiting any short positions (sell if you were anticipating on a price drop).
• Trend change (small body candles with upper and lower shadows)
  • These candles suggest a likely change in trend, which indicates market indecision.
  • Risk-tolerant traders might take a position (buy or sell). However, more cautious traders might wait for further confirmation before making a move.
• Downtrend (filled/red candles)
  • These candles indicate a downward trend.
  • Consider adding to your short positions (anticipating on a price drop) and exiting any long positions (selling if you were holding the asset).
• Strong downtrend (filled/red candles with no upper shadows)
  • These candles show a strong downward movement.
  • Stay in your short positions until there are signs of a trend change.

Heikin-Ashi charts use averages to calculate the candlesticks. Because of this, the prices shown on the Heikin-Ashi chart might not match the actual market prices. Hence, ideally, these charts should not be used alone to identify trends.

It must be noted that they are most effective when combined with other technical analysis tools and indicators. This combined approach helps find better entry and exit points, which enhances the overall reliability of your trading strategy.

The best indicators to use with Heikin-Ashi candles depend on your personal trading style and experience. Also, it's important to choose indicators that you are familiar with and have practised. Let’s see some common indicators to use with Heikin-Ashi:

• Moving averages
  Simple Moving Average (SMA) or Exponential Moving Average (EMA) can help confirm the trend direction shown by Heikin-Ashi. If the price is above the moving average, it confirms an uptrend. If it's below, it confirms a downtrend.
• Bollinger bands
  Bollinger Bands consist of a moving average and two standard deviation lines above and below it. Most traders use it to identify volatility and potential reversal points. When Heikin-Ashi candles touch or move outside the bands, it signals overbought or oversold conditions.
• Relative strength index (RSI)
  RSI measures the speed and change of price movements. It indicates overbought or oversold conditions. When combined with Heikin-Ashi, RSI confirms trend strength and signals potential reversals.

Heikin-Ashi charts are an enhanced version of the traditional candlestick charts. They smooth out price fluctuations which makes it easier to identify trends and spot reversals. By averaging price data, these charts offer clearer signals of market direction and help in determining, whether it's an uptrend, downtrend, or a trend change. Moreover, traders can use Heikin-Ashi candles to stay in trades during strong trends and exit positions as trends weaken or reverse.

It is worth mentioning that the key to their effectiveness is the combination with other indicators like moving averages, Bollinger Bands, and RSI. These indicators provide additional confirmation of trends and help traders determine optimal entry and exit points. While the Heikin-Ashi candle pattern alone may not reflect exact market prices due to their averaging method, their reliability improves significantly when used alongside technical analysis tools.

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