To understand the Heikin Ashi chart, you’ll need to understand some of its history as well as some connected terms. The chart finds its beginnings in 17th century Japan, where rice traders used many of the principles governing the chart today, to trade the precious commodity with each other.
One key tenet of the trade was using technical analysis. Technical analysis is studying the historical performance of a good or commodity in a market in order to predict its future performance. The Heikin Ashi chart is a type of technical analysis.
What is technical analysis?
Expanding on the point of technical analysis further, it is meant to show the trader at which point they should enter the market for a particular stock and at which point they should leave.
This is demonstrated by a chart. The charts have something called candlesticks. The candlesticks indicate price movements in the stock a trader is considering. If the candlestick is green, the price goes up. If the candlestick is red, the price goes down.
Like an ordinary candlestick, these on technical analysis charts have wicks. A wick is also called a shadow. It is used to show the opening and closing price of a stock for a given period.
The last terms you’ll need to understand before we go on to explain the Heikin Ashi chart are open, close, high, and low.
Remember, we are dealing with the stock market. At each day’s trade, there is an opening and closing bell. The “open” is the price of the stock at the day’s beginning. The “close” is the price of the stock at day’s end. Meanwhile, “high” and “low” refer to the maximum and minimum prices a stock has traded at over some time as represented by the wicks we spoke of earlier.
Technical analysis is based on some fundamental assumptions:
1.The market discounts everything
This means that everything that can factor into affecting the stock has been accounted for in the price. The leaves only the price to be observed for patterns
2.The price moves in trends
The underlying assumption here is that the stock prices are not randomly occurring. They will exhibit trends throughout their existence and these trends are observable.
3.Trends form a history that repeats itself
Over time, these trends develop a “history” that tends to repeat itself. Essentially, technical analysis assumes that market price trends will reoccur, and thus, one can predict what actions to take regarding a stock because of this.
There are many types of technical analysis. The Heikin Ashi chart is just one of them.
What is the Heikin Ashi chart?
A Heikin Ashi chart is different from a regular candlestick chart in that it displays averages of price movements over a period of time as opposed to day-to-day movements. This is an important distinction.
First of all, when your chart displays day-to-day movements, you see much volatility in the stock’s price, which can cause you to misinterpret its value. The Heikin Ashi is critical to accurate strategy as this chart smooths out the volatility in its display by using averages. When the price volatility or noise is filtered out, you have a much better idea of the stock’s performance.
This in fact is the entire point behind the Heikin Ashi chart, giving the trader the ability to see trends better and to see trend directions and trend strengths.
Going back to some of the terms we learned earlier:
- The shorter the wick or shadow, the stronger the trend
- Green candles with no wick on the lower part mean a strong uptrend
- Red candles with no wick on the upper part indicate that there is a downtrend occurring
There are special calculations needed to create candlesticks for a Heikin Ashi chart.
Heikin Ashi calculations
Remember we spoke about the open, close, high, and low earlier?
Deriving the candlesticks in a Heikin Ashi chart is getting data on the above positions and working out the averages over time.
The close position is an average of the open, high, low, and close for the current period.
The open is the average of the previous candlestick opens added to the close of the previous candlestick.
Open=½(Open of previous bar + Close of the previous bar)
The high is the maximum of the High, Open, and Close for a defined period.
The low is the minimum of the Low, the Open, and the Close for a defined period.
Using the Heikin Ashi chart
Keep in mind that this chart is used to recognize trends. So it tells traders what stocks it would be wise to hold onto because the price is about to go up, or which stocks to sell because the price is about to trend downward.
When using the chart, follow these general guidelines:
Changes from red candlesticks to green may indicate that the price of a stock is about to go up. If you own much of the stock, this would be a good time to hold on to it.
Several green candlesticks on a chart signal that you’ve caught an upward trend, particularly if they have no wicks. You should attempt to buy this stock or hold on to this stock if you already own it.
Meanwhile, several red candlesticks mean that the stock or security is experiencing a downward trending price. If you own a lot of stock experiencing this position, it may be best to sell that stock. Alternatively, you can buy this stock at a lower price in anticipation of it going back up.
Look out for candlesticks with small red or green areas and lower and upper wicks. This means that there is about to be a pause in a trend or a reversal of the trend. If you have been enjoying the profits of an upward trend, look out as there may be a downturn in the price of your stock. Similarly, if prices have been low, they may be about to go back up again.
If you’re about to get into the stock market, or even if you’re an experienced trader, you can see how useful a Heikin Ashi chart can be. Make it one of the tools you utilize to make the best trades possible.