Technical Classroom: How to use Heikin-Ashi candlestick for trading

There is a tendency with Heikin-Ashi for the candles to stay red during a downtrend and green during an uptrend, whereas normal candlesticks alternate color even if the price is moving dominantly in one direction. However, it really becomes most effective when confirming signals or conditions identified by additional technical analysis.

Construction of Heikin-Ashi Candlesticks

Understanding underlying formula used for the construction of Heikin-Ashi candlestick charts helps traders to take prudent decisions, while trading complex scenarios.

Normal candlestick charts are composed of a series of open-high-low-close (OHLC) candles set apart by a time series. The Heikin-Ashi technique shares some characteristics with standard candlestick charts but uses a modified formula of close-open-high-low (COHL):In the formula below, a "(0)" denotes the current period. A "(-1)" denotes the prior period. "HA" refers to Heikin-Ashi.

The Heikin-Ashi candlesticks are available on most trading platforms, such as Tradingview and MetaTrader. The Heikin-Ashi Candlesticks are also available on many free online charting sites, such as Investing.com, StockCharts.com and Yahoo! Finance.

Working of Heikin-Ashi Candlesticks

• Green candles with no lower shadow indicates a strong uptrend.
• Green candles signify an uptrend, one can add long position and exit short positions.
• Candles with a small body surrounded by upper and lower shadows indicates a trend change whereas risk-loving traders might buy or sell here, while others will wait for a confirmation before going long or short.
• Red candles indicate a downtrend: You might want to add to your short position and exit long positions.
• Red candles with no higher shadows identify a strong downtrend: Stay short until there's a change in trend.
• The averaged open and close help filter some of the market noise, creating a chart that tends to highlight the trend direction better than typical candlestick charts.
• Long down candles with little upper shadow represent strong selling pressure. Long up candles with small or no lower shadows signal strong buying pressure.
• A long hollow Heikin-Ashi candlestick shows strong buying pressure over a two day period. The absence of a lower shadow also reflects strength.
• Small Heikin-Ashi candlesticks, or those with long upper and lower shadows show indecision over the last two days. This often occurs when one candlestick is filled and the other is hollow.
• The Heikin-Ashi technique uses a modified formula based on two-period averages. This gives the chart a smoother appearance, making it easier to spots trends and reversals, but also obscures gaps and some price data.
• The main advantage is that the charts are much "smoother" looking, which helps to more easily identify the trending direction.

• Like all technical indicators, it is important to use the Heikin-Ashi Candlesticks in conjunction with other technical analysis tools.

Trading Technique:

A long green Heikin-Ashi candlestick shows strong buying pressure over a two day period. The absence of a lower shadow also reflects strength; however small Heikin-Ashi candlesticks or those with long upper and lower shadows show indecision over the last two days. Usage of stochastic and Heikin-Ashi is the most effective way while trading. Stochastic Indicator and Heikin-Ashi together are used to develop trading strategy. Key points about it are discussed below-

Buy Signal

Entry:
• Stochastic(14/3/3 ): Stochastic should be above 50 marks.
• Stochastic(50/3/3 ): Stochastic should be above 50 marks.
• Heikin-Ashi: Heikin-Ashi candlestick should be green with no lower shadow.
• SMA(20): Candle close should be above 20 SMA.

Exit:
• One can use multiple ways to book profit & exit, like stochastic near 85 or red candle or prices below 20 DMA. Most interesting aspect of Heikin-Ashi trading is trailing stop loss to low of previous candle.

Sell Signal

Entry:
• Stochastic(14/3/3 ): Stochastic should be below 50 marks.
• Stochastic(50/3/3 ): Stochastic should be below 50 marks.
• Heikin-Ashi: Heikin-Ashi candlestick should be red with no upper shadow.
• SMA(20): candle close should be below 20 SMA.
Exit
• One can use multiple ways to book profits and exit, like stochastic near 15 or green candle or prices above 20 DMA. Most interesting aspect of Heikin-Ashi trading is trailing stop loss to high of previous candle.

Conclusion

• Chartists can use Heikin-Ashi candlesticks to identify support and resistance, draw trend lines or measure retracements.
• Heikin Ashi charts can be used in the same fashion as any other chart, for finding chart patterns like triangles and wedges, or trade setups.
• The Heikin-Ashi chart is constructed like a regular candlestick chart, except the formula for calculating each bar is different.

The Author is Head - Technical & Derivative Research, Narnolia Financial Advisors.

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