Using Heikin Ashi Candles - Heikin Ashi Candlestick Patterns

Candlestick charts tell you plenty of useful information about what prices did during a trading session. They tell you where prices started off, the high and low points they touched in the course of the day, and where they ended up. In this way, they’re like a summary of a day in the Tour de France cycle race, telling us the time and location where the cyclists set out; the highest and lowest altitudes they clocked along the way; and the time and location where they lay down their bikes at the end.

There’s a special kind of chart that’s designed to excel in revealing trend direction and strength. Going by the intriguing name of Heikin-Ashi, it looks noticeably different – and pleasanter to the eye – than the traditional kind. As we’ll see, its heightened aesthetics come down to its refusal to record every jittery jump and fall of prices in a session. It’s all these tiny fluctuations that tend to give bull runs a mottled appearance on traditional candlestick charts. Even when prices are tracing a clear path upwards, the dominant green colour is usually littered with streaks of red where prices made little bearish dips along the way.

Heikin-Ashi traders want to eliminate the distortions made by flickering prices. They don’t want to be fooled into believing prices have chosen a direction when they haven’t. They don’t want to be led into following false bearish reversals when a bull run still has plenty of room to go. And to be honest, they’re sick and tired of seeing irrelevant price data on their charts in any shape or form!

That’s why they decided to build an entirely unique kind of candle. This one won’t function like a news report on the tour taken by prices today. Rather, it will average out prices for today’s session and compare them with yesterday's. If there’s an improvement to speak of, today’s candle will be bullish green. If not, it will appear bearish red. Thus, a Heikin-Ashi price bar gives you a record of today’s price action in the context of the pre-existing trend, and not in its own right.

If Heikin-Ashi traders were to report on the Tour de France, they’d tell us how the average speed of the riders on today’s stage compared with their average speed on the previous stage. This way, we’d know whether they were building up stamina or losing it as the race progresses. Hitch you bike up to our trailer as we take you through some of the ins and outs of Heikin-Ashi candle charts.

Introducing Heikin-Ashi Candles

Meet Mr. Heikin-Ashi. That’s him on the bottom of the chart, looking a lot sharper than his traditional counterpart up top. You can immediately appreciate some of the benefits Heikin-Ashi candles bring to the table. Specifically, you can see how the bearish and bullish trends openly reveal themselves in uniform patterns.

The bullish surges starting at the beginning of September and a week into October appear in untainted green, lending you a much stronger sense of confidence in the trend than the traditional candles on top. Also note the fact that the Heikin-Ashi green candles are considerably taller, lack lower shadows, and possess long upper shadows. For somebody evaluating the Heikin-Ashi chart on September 12th, it would seem like a slam dunk to go long on this security, but this could not be said for someone looking at the regular candle chart above it.

Let’s get more specific. Look closely at the traditional chart on the 17th and 18th of September, where we have two consecutive candles with tips touching the 1725.00 level, the first one red and the second one green. Both have a short lower shadow and a long upper shadow. On close inspection, the base and tip of the green candle are slightly below the red one’s base and tip, respectively. Imagine it was the 18th of September right now and you only had the upper chart to work with. What would you conclude about the trajectory of prices?

Well, you may decide they’re about to head upwards because this two-candle combination looks a lot like a Piercing Line chart pattern, which signifies a bullish reversal. Just like a Piercing Line, it occurs during a downtrend; prices for candle two open lower than where they closed in candle one; and prices for candle two close more than two-thirds of the way up the length of candle one. And yet, how wrong you would have been! Prices decidedly did not shoot up from that point.

If, however, you opened up your Heikin-Ashi chart on that day, you would have seen there was an undeniable bearish trend controlling price action. In the days that followed, it became clear that this trend still had a way to go. How wonderful (1) to be spared the false Piercing Line bullish signal on September 18th and (2) to get a clear indication of the dominant price trend between September 19th and 22nd!

The Heikin Ashi Formula

How do Heikin-Ashi candles manage to pull this off? The answer is that they monitor price action in a totally different way to regular candles. This is evident from their underlying formula, below.

Open = (Previous session’s open + Previous session’s close) / 2

Close = (This session’s open + high + low + close) / 4

High = The highest of this session’s high, open, and close

Low = The lowest of this session’s low, open, and close

We see from the Heikin-Ashi formula that, although Heikin-Ashi candles resemble regular ones, they are far removed from them in their essential functionality. For a start, their openings do not indicate where prices started for a session. That information, along with the point where prices later closed, is actually missing from Heikin-Ashi charts, and this is a drawback about which Heikin-Ashi traders are well aware. If you want to know the exact prices where the trading session opened and closed – and you probably will, in order to set your stop-loss orders, gauge trend momentum, and fix a more precise entry – don’t ask Mr. Heikin-Ashi because he simply doesn’t know.

The open for a Heikin-Ashi candle is an average of the previous session’s prices. The close is an average of this session’s prices. Thus, when the bar comes out nice and green, it shows – not that prices rose overall between the session’s start and close – but that the average level reached by prices in this session exceeded last session's average level. Another way of putting this: Prices are trending bullishly with respect to the previous session.

Now we understand better how Heikin-Ashi candles go about their task of tracking the trajectory of prices, and also why they do it so well. Through averaging out price levels and then comparing them session to session, the trend of price movements is enhanced at the expense of actual price levels. The other task at which they specialize is gauging the strength of those trends, which we’ll look at in the next section.

Heikin-Ashi Trading Strategy

Returning to the bullish trend in our Heikin-Ashi chart from the second week of October: A reason why traders would feel particularly confident about it is that it’s shadowless. The long series of green candles dominating the chart lack lower shadows completely, and this lends the bull run the status of an especially strong one. Likewise, the series of red candles extending from September 17th until September 20th totally lack upper shadows. This is a key indicator of trend strength in Heikin-Ashi candles: the fact that prices didn’t double back to form shadows on the opposite ends to their trajectories. Even without this factor, the mere presence of a green candle signifies an upwards trend in the making, while a red candle shows prices are trending down. Each of these on its own makes for a stand-alone signal to, respectively, go long or short on the security.

Now taking a look at the Heikin-Ashi chart between September 28th and October 4th: You’ll see a series of short candles with long shadows on either side. Gaze up at the regular candle chart and you’ll see something similar starting on the 26th of the month. Whether you’re in the traditional world or the Heikin-Ashi one, these patterns indicate indecisiveness on the part of traders and often precede a trend change. In our case, these candles acted true to form, prefiguring a major bullish turnaround.

Which brings us to an important point: Heikin-Ashi candlestick patterns are mostly the same as the regular kind. This means you should keep an eye out for Spinning Tops, Dojis, Falling Wedges, and Triangles on your Heikin-Ashi charts just as you do on your regular candlestick charts.

Summing Up Heikin Ashi candlestick patterns

Because of the power of Heikin-Ashi charts to dull down the noise of price jitters, thus leaving clearer impressions of the overarching trends in the market, it’s definitely worth giving them a spin in your online trading strategy. One study conducted with these charts, analyzing one year of price action in ten pre-chosen stocks, found they correctly forecast the next session’s trend 72% of the time. They’re usually not used in isolation, though. Traders tend to combine them with other indicators, in particular with MACD, RSI, and Bollinger Bands, in order to get the best results. Do what works for you in this regard.