How to Use Heikin-Ashi Charts in Forex

The post How to Use Heikin-Ashi Charts in Forex by Jay and Julie Hawk appeared first on Benzinga. Visit Benzinga to get more great content like this.

Japanese candlestick charts have become a standard technical analysis tool for many forex traders. In just one candle, a currency trader can see an exchange rate’s open, high, low and close for a particular timeframe.

Although similar to those traditional candlestick charts, Heikin-Ashi charts and their candlestick formations differ significantly. The Heikin-Ashi candlestick uses data from the previous candle formation and combines it with data from the current candle formation to create a combination candlestick that smoothes exchange rate data substantially. 

Keep reading if you want to learn more about Heikin-Ashi candlesticks and charts and how you can apply them to improve your forex technical analysis. 

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What are Heikin-Ashi Charts?

In Japanese, the two words Heikin-Ashi mean “average pace,” so a Heikin-Ashi candlestick represents the average pace of a currency pair’s exchange rate. Heikin-Ashi candlesticks are created using two-period moving averages instead of the observed open, high, low and close data that is used to create traditional candlesticks and bar charts. A Heikin-Ashi chart is a chart made up of Heikin-Ashi candlesticks. 

The invention of the candlestick chart in its traditional and Heikin-Ashi forms has been credited to a rice merchant in Japan known as Munehisa Honma. Many traders consider Honma the father of price action and technical trading since he was the first to use candlestick charts to determine the market trend and find profitable trades.

Honma lived from 1724 until 1803 and was the son of a wealthy rice merchant. Groomed by his rich father to take over his business, Honma began trading rice in his home port of Sakata due to the distance of the nearest rice exchange in Osaka. Since Sakata rice traded remotely, traders in Osaka were allowed to trade with coupons that later evolved into futures contracts. 

In addition to pioneering technical analysis of the rice market using candlestick charts, Honma accumulated a notable fortune throughout his life that would exceed $100 billion in today’s money. By researching and charting rice prices and developing a historical record, Honma became aware of recurring patterns, leading him to write the Sakata Rules that lay out the basis for his trading strategy. 

Honma’s candlesticks, charts and trading strategies continue to be used by traders worldwide today. Apparently, trader psychology has not changed much since Honma wrote his famous 34-page book called “The Fountain of Gold – The Three Monkey Record of Money” in 1755. 

In it, Honma gives invaluable advice on trading and market psychology from a Japanese philosophical perspective. Aspiring forex traders would be well advised to review this short book and study the insights of one of history’s pioneering and highly profitable traders.   

Heikin-Ashi Formula

The open, high, low and close (OHLC) for each Heikin-Ashi candle is calculated as shown in the formulas below from the OHLC data observed for a particular time period or bar and the previous bar:

• Close = [Open + High + Low + Close] / 4
• Open = [Previous Open + Previous Close] / 2
• High = Max [High, Open, Close]
• Low = Min [Low, Open, Close]

Note that the Heikin-Ashi Close formula uses data from the current bar, while the Heikin-Ashi Open uses data from the previous bar. Also, like a bar chart, a Heikin-Ashi candlestick chart can be made up of candles computed for different time periods, including hourly, daily, weekly and monthly. 

Key Differences from Traditional Candlestick Charts

To understand Heikin-Ashi candlesticks, you should first learn how regular candlesticks work. A traditional candlestick represents the forex market’s OHLC exchange rates for a particular time period and currency pair. 

Candles also have one of two colors. One is typically a lighter color for a rising exchange rate and one is a darker color for a declining exchange rate, although many candlestick charts use green, clear or white for an up candle and red or black for a down candle.

The body of a candlestick is bounded by the opening and closing exchange rates of the currency pair for the time period, while the wicks or shadows that protrude from the body of the candle represent the lower and upper ranges of the exchange rate for that period. 

An up candle without wicks shows that the currency pair opened at the low of the period and closed at the high, with no trading taking place at exchange rates below the open or higher than the close. A down candle without wicks shows that the currency pair opened at the high of the period and closed at the low.

As you can see in the chart below, the Heikin-Ashi candlestick chart looks similar to a traditional candlestick chart, with the main difference being in the calculation of each candle as explained in the previous section. The Heikin-Ashi chart is based on modified candlesticks that depict exchange rate action in a currency pair averaged together, so they eliminate much of the noise you can see on traditional candlestick charts.   

Graphic depicting a Heikin-Ashi chart above and a traditional candlestick chart below explaining how Heikin-Ashi candles are drawn from the original traditional candlestick chart. Source: StockCharts.

The Heikin-Ashi candlestick differs from the traditional candlestick chart in some key features. For example, the chart above shows how gaps that appear on normal candlestick charts do not appear on Heikin-Ashi charts because the candle is drawn from an average of the previous candle. 

You can see how two small white candles with lower lows on the traditional chart become one black candle on the Heikin-Ashi chart. The combination of a long black candle with a white hammer on the traditional candlestick chart becomes a long black candle on the Heikin-Ashi chart. 

Note that the fourth box shown in blue on the lower chart contains two candles, one white and one black, which together become an indecisive Heikin-Ashi candle. Finally, the fifth box shown in green on the traditional chart contains two small white candles that become one long white candle on the Heikin-Ashi chart.   

How to Read Heikin-Ashi Charts

While some parallels may appear on both types of charts, keep in mind that patterns that appear on traditional candlestick charts may not have the same meaning on Heikin-Ashi charts, although technical forex traders can obtain useful information by examining both types of charts.

Prevailing trends tend to appear more pronounced on Heikin-Ashi candlestick charts than on traditional candlestick charts, which makes past exchange rate movements and current trends considerably more evident. Candlesticks in Heikin-Ashi charts also tend to stay one color over a longer period of time, which indicates a strong directional trend in the exchange rate.  

The wicks of Heikin-Ashi candlesticks generally appear shorter than traditional candlesticks, and a shorter wick indicates a stronger trend. For example, a series of large white candles with no lower wick on an Heikin-Ashi chart would be very bullish, while several large black candles with no upper wick would be considered very bearish.

Potential trend reversals can be identified using Heikin-Ashi candlesticks by looking for small-bodied candlesticks with long wicks. Market uncertainty also shows up on Heikin-Ashi charts when a small candle appears. Depending on previous candle formations, this indication could also signal the reversal of the previous trend. 

Other market reversal indicators that appear on Heikin-Ashi charts are rising and falling wedge patterns. Trading a rising wedge pattern typically requires waiting until the market breaks down below the bottom line of the pattern while trading a falling wedge requires waiting until the market breaks above the pattern’s upper line. These breakout signals would indicate that the trend was reversing.  

Using Heikin-Ashi Charts with Other Technical Indicators

Many traders who use Heikin-Ashi charts combine them with technical indicators like moving averages, Bollinger bands, the Moving Average Convergence-Divergence (MACD) indicator, Fibonacci retracements and the Relative Strength Index (RSI). The best way to combine these indicators with Heikin-Ashi charts is similar to the way they are used along with regular candlestick charts and patterns.

For example, you could superimpose a set of Bollinger bands over the Heikin-Ashi candlestick chart for a currency pair. When the market is rising strongly, the exchange rate will bump along the upper band of the indicator. If the market then falls below the middle line of the indicator, a further reversal to the downside would be likely.  

Key Heikin-Ashi Trading Strategies

Trading strategies can help you identify when to take a position, how to scale into a position and where to set stop-loss orders to prevent excessive losses in case your market view was incorrect. Twol Heikin-Ashi trading strategies that forex traders can use to improve their trading profits appear below. 

• Identify a strong trend: Heikin-Ashi charts can be used reliably to catch the start of a strong trend in either direction. For example, when a candlestick without shadows in one direction appears, it signals that a strong trend is starting in the opposite direction. Thus, a downward trend would be expected when candlesticks without upper shadows appear, while candlesticks without lower shadows signal an upward trend. If more than one candlestick without a shadow in a particular direction appears, it signals an even stronger new trend. 
• Small-bodied candlesticks signal a pause or reversal in a trend: When candles with small bodies appear on a Heikin-Ashi chart, they signal that a trend will soon take a break and consolidate or reverse direction. This situation often presents a good time to take profits. 

Common Mistakes With Heikin-Ashi Charts and How to Avoid Them

Heikin-Ashi charts are drawn based on averages instead of current exchange rates. This factor can result in missed opportunities, and trade entry and exit signals can be delayed. These charts can give false signals in consolidating or ranging markets that can result in costly whipsaws. 

Using Heikin-Ashi charts along with other technical indicators can help you confirm the signals you observe and filter out false signals that can cost you money. Also, by reviewing Heikin-Ashi charts for several timeframes, you can better identify the underlying trend’s direction so that you can trade along with it. 

Additionally, Heikin-Ashi charts can obscure helpful candlestick formations that can be seen on regular candlestick charts, including exchange rate gaps, Doji patterns and spikes that can provide traders with valuable information. To avoid this pitfall, you can use Heikin-Ashi charts along with regular candlestick charts. 

It also makes sense to use prudent money and risk management methods when using Heikin-Ashi charts to provide you with trading signals. These techniques include sizing positions affordably and setting sensible stop loss and take profit levels.

Advantages of Heikin-Ashi Charts in Forex Trading

Heikin-Ashi charts have several important advantages that include:  

• Readily available: Heikin-Ashi charts are available on most technical analysis and sophisticated trading platforms without additional charge. If you use the MetaTrader 4 trading platform from MetaQuotes to trade forex, then you can use the custom indicator available here to draw Heikin-Ashi charts for currency pairs. 
• Reliable: Heikin-Ashi charts offer forex traders a reliable and accurate market indicator. 
• Easy to read: Many traders find Heikin-Ashi candlesticks easier to read than traditional candlesticks to identify market trends and anticipate future moves.
• Noise reduction: Heikin-Ashi charts help traders filter out market noise, which makes it easier for them to identify trends and signals. 
• Flexible: You can use Heikin-Ashi charts along with other technical indicators to confirm trade signals. You can also use the charts in any timeframe. 

Disadvantages of Heikin-Ashi Charts in Forex Trading

Despite the advantages of using Heikin-Ashi charts, they do have some drawbacks that include: 

• Lag: Since historical exchange rates are used to compute Heikin-Ashi charts, they provide signals based on old market data.  
• Missing information: Certain helpful information that appears on regular candlestick charts does not show up on Heikin-Ashi charts. These include exchange rate gaps and spikes, actual opening and closing exchange rates and useful candlestick patterns like Dojis. 
• Loss of Wave Structure: Traders using Elliott Wave Theory will probably find that Heikin-Ashi charts tend to obscure the inner wave structure of market moves. 

Are Heikin-Ashi Charts Useful for Forex Traders?

Yes, Heikin-Ashi charts can be useful to forex traders. Forex traders who use a long-term or medium-term trading strategy will probably benefit the most from using this type of candlestick chart since it can be especially useful for identifying major and minor trends and for assessing when the market is ripe for a trend reversal. 

In contrast, traders who use short-term forex trading strategies can probably benefit more from using regular candlestick charts since they include exchange rate gaps and spikes as well as opening and closing prices. Currency traders actively using Elliott Wave Theory will probably find that Heikin-Ashi charts make identifying market waves harder, so they will typically prefer to use regular candlestick charts. 

Frequently Asked Questions

The post How to Use Heikin-Ashi Charts in Forex by Jay and Julie Hawk appeared first on Benzinga. Visit Benzinga to get more great content like this.