Monday 23 April 2012

Heikin-Ashi Basic Trading Strategy

A basic trend following trading strategy can be created around Heikin-Ashi candlestick charts. 

For more information on what Heikin-Ashi candlesticks are, see this article that explains them.

Since Heikin-Ashi candles are used to reduce price noise and clearly display trends in the market, using the chart type to find and profit from trends can provide high probability setups during times when the market has a trending tendency.

Any timeframe can be used, and this applies to nearly all markets. However, you must do your own due diligence by back/forward testing it yourself and only you are responsible for your trading activity.

What you'll need: 


Heikin-Ashi charts or indicator within your platform. You'll find Heikin-Ashi quite common on most modern platform. Metatrader, Tradestation, and equity charting platforms like eSignal have it for sure.

We'll start by applying a 50SMA to the chart. This moving average will serve to set the direction we trade. 

Take a trade long when: 


If the current Heikin-Ashi candlestick crosses up over the 50SMA, AND the current bar's open is higher than the previous bar's low (which suggests price is starting to move consistently up over the last two bars,) you'd take a long entry at the close of the current bar.

You can set a stop below the low of the current price bar, and trail it up to below the previous price bar as time progresses (or, another method would be to exit once two Heikin-Ashi candlesticks appear that signal a trend in the opposite direction. This will depend on what you are trading and what works best given your backtesting on said trading instrument.)

You will keep trailing your stop til you've been stopped out, and if the trend is strong, you can ride out a very profitable trade using this method.

To illustrate, it should look like this:

The green arrow shows the candle that crosses triggers our long signal by cleanly pushing through the 50SMA, and the blue line is the price level where you would have opened the position.


Take a trade short when: 


If the current Heikin-Ashi candlestick crosses down under the 50SMA, AND the current bar's close is lower than the previous bar's high (which suggests price is starting to move consistently down over the last two bars,) you'd take a short entry at the close of the current bar.

Again, you can set a stop above the high of the current price bar, and trail it down to above the previous price bar as time progresses (or, another method would be to exit once two Heikin-Ashi candlesticks appear that signal a trend in the opposite direction. This will depend on what you are trading and what works best given your backtesting on said trading instrument.)

You will keep trailing your stop til you've been stopped out (hopefully in profit,) and if the trend is strong, you can ride out a very profitable trade using this method.

To illustrate, the short trade would look like this:


Keep in mind, by trailing your stops to the high/low of the previous candle, you're tightening and reducing risk aggressively, often quickly locking in a trade 'in-profit'. In the short example image, you would have been stopped out near the top of the first white candle after the entry, that's a very precise method of keeping profits and knowing when to get out.

Final thought:


We know this works best when the market is trending, and remember to look for price moving cleanly through the 50SMA. For instance, you don't want to take a trade if the price movement makes the chart look like this when the candle closes through the SMA: 

 
Feel free to adapt this method and tweak it to your favourite market. 

That's it for now, happy trading! 

Sunday 22 April 2012

What is Heikin-Ashi?

Heikin-Ashi is a method of candlestick charting that helps traders identify trends in the market by reducing price noise.

It appears similar to regular candlestick charting but is very different in how the candles are calculated.

Normal candlesticks use the following price information during the chart's time period: Open, High, Low, and Close.
Heikin-Ashi attempts to smooth out the noise by adjusting these values before they are painted. 

The formula: 
  • The candle's open price is set to the average of the previous candle's open and close prices.
  • The candle's high price is set to the highest value of the current period's high, open, or close prices.
  • The candle's low price is set to the lowest value of the current period's low, open, or close price.
  • The candle's close price is set to the current periods average of the open, high, low, and close prices divided by 4.

The result takes a chart that looks like this (regular candlesticks): 


And turns it into this (Heikin-Ashi): 



A series of candles with no lower wicks are used to identify strong up trends, while a series with no upper wicks is used to identify strong down trends.

As you can see, the price trends are quite a bit more clear on the Heikin-Ashi chart than a traditional candlestick chart.