ForeCastle

Talking Points:
-Why Mess With a Good Thing?
-The Purpose of Heikin-Ashi
-Trading With New Vision

“You can observe a lot by just watching.”
Yogi Berra



Candlesticks are a great tool to help you see sentiment in real-time. However, there is something deeper than what the candlestick is showing you. That something deeper is your fear of being on the cusp of a reversal against your position. Therefore, a false signal of Candlesticks can be costly where as Heikin-Ashi would have likely kept you in the trade as this article will explain. Heikin-Ashi is a free indicator available to be added, like a moving average, to your chart.

Heikin-Ashi (Right) Smooth Out Trends



Why Mess With a Good Thing?

The short answer to this question is that there is a lot of noise with candle to candle price action which can make some candlestick signals misleading. How they are misleading is when you get more noise than signals. Even though candlesticks can help you to find & confirm higher-probability entries when a reversal is shown by other tools or techniques, traders need to be aware of a potential false signal.



Heikin-Ashi also simplifies the process of visualized trading. If you’re familiar with Candlesticks, you may be aware that there are over a hundred documented Candlestick patterns. This means that not only is it difficult to learn all candlestick patterns, but as you can see above, there not always reliable. The highlighted boxes above are to highlight reversal signals, known as Shooting Stars that did not result in a true market turn and could be seen as noise vs. a true signal.
Bottom Line: Candlestick Trading doesn’t always provide clean signals and can produce noise in a strong trend.

The Purpose of Heikin-Ashi

Heikin-Ashi is a visualized balanced candle so that you can filter price of the current move for the overall trend. Heikin-Ashi is sometimes known as an average candle to replace or confirm candlestick patterns. As you can see from the calculation, Heikin-Ashi averages out the prior candle to build a bias for the overall trend continuation and the current candle.

Heikin-Ashi Formula

Close = (Open+High+Low+Close)/4
Open = [Open (previous bar) + Close (previous bar)]/2
High = Max (High,Open,Close)
Low = Min (Low,Open, Close)

By looking at the calculations, you’ll be able to see that Heikin-Ashi is a technique which looks at the average price of a candle and uses that to plot the next candle’s open. Because the current candle is plotted based on the prior candle’s average, you’ll notice a sequence of same-colored candle bodies to show a clean trend with longer bodies & candlewicks in the direction of the trend showing you strong trends.

Few Red Heikin-Ashi Candles Show a Strong Trend



Trading With New Vision

Heikin-Ashi doesn’t look for traditional candlestick patterns. Rather, when using Heikin-Ashi, you’re looking for a strong trend to stay in while always managing risk with a trailing stop. When the bodies get weaker / smaller or begin to change color, then a reversal and / or correction is on hand, it’s time to step aside from the trade as the future is increasingly uncertain in respect to the prior trend you were trading.

The strongest trends are displayed with a shaved Heikin-Ashi candle. If you are trading an uptrend with Heikin-Ashi applied to your charts, and the current candle shows no candlewick to the downside, the trend is very strong and it is best to stay in the trend until either a red candle appears which my preference is or a bottom candlewick forms. This form of trade management provides an active and intelligent trailing stop so that you’re only exiting on a likely consolidation that can chew up time or a reversal is on hand.

Trailing Stop Example




Closing Thoughts

Heikin-Ashi allows you to “trick” your eye to staying in the strong trends that can throw off weak or false reversal signals. This trick is based on averaging the prior candle so that the current price action is only filtered through the prior candle as opposed through the time of the prior candle. If you have trouble jumping out of a trend well before it’s done, Heikin-Ashi could be a helpful indicator for you.

Happy Trading!
---Written by Tyler Yell, Trading Instructor


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