The vast majority of Forex traders knows that the market is full of unnecessary noise which often does not come in line with the current trend. Many currency pairs, commodities and stock indices sometimes show an unexpected performance, charting false breakthroughs of resistance/support levels, while technical indicators provide fake signals. This is why many technical analysts use additional tools to smooth out the noise and exclude unnecessary price fluctuations from the overall equation, which is supposed to deliver an answer to the most essential question - where the market will head in the near future.
After all, Forex trading comes down to determining whether the current price is low enough to buy or high enough to sell. That also relates to currently profitable positions in a portfolio as the dilemma turns into a simple question: would the market move further in my direction or is it the bottom/top? This is why most of the technical analysts are keen on seeking reversal points and levels when the market conditions change, forcing traders to shift the sentiment and influencing the demand-supply relation. The market’s noise is the crucial factor preventing traders from the precise calculation of levels where the trend is getting exhausted and the likelihood of reversal is increasing. With all that in mind, an alternative chart view - Heiken Ashi - was invented.
What is Heiken Ashi?
As readers could already guess, Heiken Ashi strategy is another intriguing Japanese phrase related to candlesticks - the most widely used form of displaying price charts in the financial markets. The phrase itself means ‘Average Bar’ in Japanese, and it was designed to use additional filtering to exclude unnecessary noise from the chart. Although Heiken Ashi view is not so widely used as Japanese candlesticks, it allows traders to identify real trend effectively, ignore false price movements and find divergences to boost profits from Forex trading.
How does Heiken Ashi chart look like?
To see the difference, simply look at two charts for the same currency pair on the same timeframe.
It’s obvious that the Heikin-Ashi chart has completely different representation even though the overall price change is similar. Both candlesticks or bars have the same four parameters to be indicated on the chart - open, close, high and low rates. However, the method of calculation those rates is different for Heiken Ashi.
How to calculate Heiken Ashi candles?
Below is the list of formulas used in the calculation of Heiken Ashi bars:
- Open price is equal to the sum of the open price of the previous bar and close price of the previous bar divided by two;
- Close is a simple average of open, close, high and low rates;
- High is the maximum rate between the high, open and close price;
- Low is the minimum price from the low, open and close rates.
If you like this strategy, you might also be interested in this Grid trading strategy
How to read Heikin Ashi candles?
Similarly to Japanese candlesticks, Heiken Ashi bars are red when the close price is lower than the open (bearish) and green when the price change is bullish. However, Heiken Ashi bar might have a different colour from Japanese candlesticks due to different mathematical formula of calculating those rates, and that’s the first sign of a divergence, which will be explained in detail below. The same meaning is represented when Heiken Ashi bars change their colour, signalling a trend reversal. But with a closer look, the difference will become more clear. Let’s describe a couple of price action examples to see what does this chart view show.
Example of divergence
The first chart below shows the weekly performance of USD/CAD. The latest Japanese candlestick is bullish (green) with the open rate at 1.31783 and the close rate at 1.32861
In contrast, the weekly Heiken Ashi bar is bearish (red) and it shows the real weekly close rate (1.32861) and a weighted average rate of 1.32200, which is the result of its mathematical formula mentioned above.
That’s exactly the divergence between current market price and weighted average value. In this case, Heiken Ashi bar points to overbought conditions of USD/CAD on a weekly basis compared to the weighted average rate. Therefore, it would be attractive to go short on the pair until the bar changed its colour to green as a confirmation of the bullish upswing. If that did not happen, the recent green candlestick will be considered as a false movement, and the exchange rate will drop.
Example of a reversal signal
Here is another divergence which helped to determine a trend reversal. On August 14, GBP/USD charted a red bearish candlestick after potential U-turn signal. The main meaning of that red candlestick in Japanese patterns is that it denies the reversal, pointing to further bearish continuation.,Here is the screenshot:
But if traders looked at the same currency pair on the same timeframe but with Heiken Ashi indicator, they would notice that the same candlestick was green (bullish) but not red (bearish), which confirms the previous bullish reversal signal. The divergence in two types of chart view acted as confirmation of the reversal and helped traders to go long on GBP/JPY. Just look where is the exchange rate now.
How to use Heiken Ashis candles?
Coming back to the background of this chart view, it’s worth reminding that the primary goal of these mathematical formulas is smoothing out unnecesary market noise. At the same time, Heiken Ashi Forex strategy relfects most of the scenarios which might happen with the price action, inluding trend reversal as retracements. Below are several tips on how to take advantage of this technique.
If a trader holds a profitable position in his portfolio, and the trend moves in the right direction, he’s always asking himself a simple question whether the market would be so kind as to move in the same direction further and give more profits or is it going to reverse the trend? The choice between those two options is crucial for the overall profitability and the importance of it increases during a counter-trend retracement. Heiken Ashi strategy helps traders to take profits in time before the market eliminated all of the current gains. The main condition to take profit is as follows.
Traders should take profits from current open positions when Heiken Ashi bar changes its colour from green to red in an uptrend (to close long positions) and from red to green during a downtrend (to close short positions).
An example below shows that Japanese Candlesticks did not show a clear reversal signal in contrast to Heiken Ashi bars, which changed the colour. The profit from long positions on gold was taken in time.
Long wicks and shadows
Another advantage of the Heiken-Ashi method is related to the indecisive market’s performance when buyers and sellers fight for a crucial resistance or support level. In this case, Heiken Ashis wicks have a similar meaning to Japanese candlesticks shadows as they point to strong demand or supply at a certain price level. Besides long wicks, the length of the bar’s body also matters as it points to a significant change in the recent momentum. For example, if the body is small compared to the length of wicks, and if it is placed inside the previous bar’s body, then a reversal is likely, even if the colour was not changed. The weekly chart of gold below shows such an example. As a result, Heiken Ashi showed a perfect moment to take profits from long positions, as well as pointed out a strong sell-signal with the following bar as it changed the colour.[h2=|Long wicks and shadows]Using technical indicators with Heiken Ashi charts[/h2]
Alongside with the graphical analysis, Heikin-Ashi trading strategy works well in combination with widely-used technical indicators. Pointing to a trend’s direction is not enough in terms of profitable daily FX trading as there is also a need to identify possible depth of retracements. Ichimoku Cloud trend indicator is a perfect addition to the weighted average formula as besides smoothing out the market noise such a combinations allows forex traders to make more accurate entries and thus increases profitability. Below are several examples of trading signals.
Buying-lows on a test of Ichimoku support
The screenshot below shows a clear uptrend on USD/JPY hourly chart. As any strong trend, the bullish action requires healthy bearish retracements, which give entry opportunities to jump in the follow-by trend strategy. However, the main question is how to distinguish a retracement from reversal? The Ichimoku Cloud trend indicator has a multi-level support range. Once the rate tests the Base Line (brown) but fails to breach it by close price, a strong buy-signal occurs (1). Another example is a deeper bearish bounce as USD/JPY crossed the BaseLine from above. In this case, the next crucial support level is the upper band of the Ichimoku Cloud. As the chart shows, the Heiken Ashi bar did not close below it during the test. That’s a strong buy-signal as well. A confirmation has to come through and bars change the colour, pointing to the bullish continuation rather than a bearish reversal.
Selling-highs in uncertainty zone
In March 2019, NZD/USD had a deep bullish retracement. Heiken Ashi bars entered the Ichimoku Cloud, which indicates the uncertainty zone. However, the close rate of the bar highlighted with the red arrow on the weekly chart below printed a strong sell-signal even though its body was green. The upside swing failed to break through the upper band of the cloud, which showed a strong resistance level. As a result, the next bar changed the colour and NZD/USD continued the long-term downtrend, remaining in the same descending green channel. The signal was also confirmed when close rates went off the span.
Although the Heikin Ashi charts view has quite a complicated formula of calculating open, close, high and low prices, and rates often differ from traditional Japanese Candlesticks, the system allows Forex traders to predict the trend’s direction more accurately, points to divergences and smooths out fake market noise. The method also works well in combination with different technical indicators as filtering price fluctuations might increase the indicator’s efficiency and reduce the number of false trading signals.