What are Heikin Ashi candles and how to read them?

What are Heikin Ashi candles?

Heikin Ashi (HA) is a type of candlestick chart that can aid traders in visualizing trends. Heikin Ashi translates to "average bar" from Japanese, and it is meant to filter out the "noise", making it easier to identify trends. Heikin Ashi does not just consist of the price movement of the specific period but also includes past price action.

How do Heikin Ashi candles work?

Heikin Ashi can be helpful for spotting trends by showing only green candles during a bull run and red candles during a decline.

The reason for this is the way the candles are calculated. Heikin Ashi’s formula (more on that later) creates a smoother candle, and since prices are rising during a bull run, the close price will naturally be higher than the open price. While classic candlesticks can contain a lot of noise, Heikin Ashi filters out a lot of that.

Let’s compare a traditional candlestick chart with a Heikin Ashi chart during an uptrend:

Compared to traditional candlesticks, Heikin Ashin is all about:

1. smoothing price action out, leading to less "noise"
2. visualizing the prevailing trend in a clearer way
3. having a different formula that takes the average of the previous candle (leading to a lag)

How to read Heikin Ashi candles in charts

Heikin Ashi charts can be used across all markets and timeframes. They are particularly useful for identifying trends.

HA candlesticks have the following characteristics:

1. The highest value is the top of the upper wick
2. The lowest value is the bottom of the lower wick
3. The body of the candle consists of the difference between the session’s open and close price.

A green candle indicates that the closing price was greater than the opening price, while a red candle shows that the closing price is lower than the opening price.

If you see a series of green candles with little or no lower wick, you have spotted an uptrend. On the other hand, a series of red candles with little or no upper wick indicate a prevailing downtrend.

Heikin Ashi is also useful for spotting a reversal. A candle with a small body and both upper and lower wicks can indicate an ongoing fight between bulls and bears. Meanwhile, if you see a series of green candles and a red candle appears, that could be the sign of a trend reversal.

Finally, if candlesticks frequently alternate between green and red with long wicks, that signals an ongoing consolidation phase.

How are Heikin Ashi candles calculated?

Traditional candlesticks are calculated using the OHLC (open-high-low-close) method, while Heikin Ashi uses the COHL (close-open-high-low) method. Let’s take a closer look at what COHL means when using Heikin Ashi.

Close = (open + high + low + close) / 4

which gives you the average of the open, high, low, and close prices.

Open = (Previous open + previous close) / 2

The open price of the current candle is determined by getting the average of the previous candle’s open and close.

High = max

Represents the highest price level reached in the period.

Low = min

Represents the lowest price level reached in the period.

How to use Heikin Ashi in trading

Heikin Ashi can be used on their own or in combination with technical indicators. The best part is that they are versatile, working on any timeframe and applicable to any trading instrument.

How traders use Heikin Ashi can also vary. Some traders actively use it to generate trading signals, while others use it purely as a supporting tool. For example, a trader might use Heikin Ashi as an indicator of the trend strength but not use it at all in the decision-making process (entry/exit).

Trading strategies based on Heikin Ashi can generally be divided into trend-following and trend-reversal.

A trend-following strategy has the goal of capturing as much of the up- or downtrend as possible.

A series of green candles with no or small lower wicks indicate strong upside momentum. A trader could be looking to buy and exit the trade once a candle with a small body and wicks or a reversal signal appear.

On the other hand, a series of red candles with little to no wicks indicates a downtrend, presenting potential selling opportunities. A trader could sell and keep the trade open until there is a candle that indicates a consolidation or potential reversal.

To identify a trend reversal, a candlestick with a small body and long wicks on both sides is observed, indicating a struggle between buyers and sellers to control the price direction.

Let’s take this example: USOIL was trending higher with a long series of green candles. However, a red candle suddenly appears, which highlighted that upside momentum is weakening and that there could be an imminent trend reversal.

Heikin Ashi can easily be combined with technical indicators, such as moving averages, the relative strength index (RSI), or the MACD. Traders can use oscillators such as the RSI to determine whether a market is overbought or oversold. A sell signal when the RSI is indicating overbought conditions is favourable, while oversold conditions are preferred when looking for buying opportunities.

Advantages of Heikin Ashi

Using Heikin Ashi (HA) has several advantages that can aid traders in their decision-making:

1. HA helps traders identify the prevailing trend by visualizing it better. A series of green candles clearly indicates an uptrend, while a series of red candles is clearly showing a downtrend.
2. HA helps to cut down the "noise" that could prevent traders from making costly mistakes by avoiding false signals.
3. HA can be used as a supporting tool or as a key component of a trading strategy.
4. HA can help traders spot a potential trend reversal.
5. HA can be used across all timeframes and applied to all instruments.
6. HA trading strategies are compatible with technical indicators.

Disadvantages of Heikin Ashi

1. Due to the method of calculation, HA is a lagging indicator.
2. The biggest issue for many traders using HA is that it does not show the actual price action. For example, the open price of the candle is based on a formula and not simply the price the instrument traded at.
3. HA is better suited for trending markets since the likelihood of false signals increases during range-bound trading.
4. HA can be applied on all timeframes but would be less suitable for scalping due to the lag.

Conclusion

Heikin Ashi is a type of candlestick chart that helps traders identify trends. By smoothing out price action, it can help cut out the “noise” and give a clearer indication of the current trend. It is a popular tool for trend-following strategies, but it can also be used to spot a trend reversal.

Heikin Ashi can be used alongside various technical indicators, including RSI, MACD, and moving averages, and can work across all timeframes. Despite the benefits, there are some disadvantages when using Heikin Ashi. Traders need to keep in mind that the chart does not show the “real” price action due to the lag and method of calculation.

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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation and needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability with regard to the accuracy and completeness of the content in this publication. Readers should seek their own advice.