since the introduction of the candlestick method to the US some two decades
ago, it caused a revolution in perceiving how the bullish and bearish forces
perform in the Western markets. It has become a popular charting tool, as traders have used candlesticks to make chart formations easier to spot and name. But interpreting candlesticks can be challenging. To make things easier, the heikin-ashi technique modifies the traditional candlestick chart. Let's take a look at how it works. The heikin-ashi method {heikin means "average" or "balance" in Japanese, while ashi means "foot" or "bar") is a visual technique that eliminates irregularities from a normal chart, offering a better picture of trends and consolidations. Just by looking at a candlestick chart created with this method, you get a good idea of the market's status and its strength. Take a look at the candlestick chart of Canon ADR in Figure 1A versus the heikin-ashi modified chart in Figure 1B. Which chart would you prefer to use?
The heikin-ashi candlestick technique uses modified open-high-low-close (OHLC) values and displays them as candlesticks. The "open," "high," "low," and "close" referred to are of the current bar. The prefix ha- indicates the corresponding heikin-ashi modified values. I have used daily data throughout this article, so one bar represents one trading day. Depending on the trading time frame, you may employ other data, such as intraday, weekly, or monthly.
The value haOpen is always set to the midpoint of the body of the previous bar, while haClose is computed as the average price of the current bar. The modified high, haHigh, is chosen as the highest value of the set {real high (H), modified open (haOpen), and modified close (haClose)}. The same logic applies to the definition of the modified low: It is the lowest value in the set {real low (L), modified open (haOpen), and modified close (haClose)}. The first sidebar, "Heikin-Ashi OHLC Values," details how to compute heikin-ashi values using Excel.
Looking at charts is the best way to understand the main features of the heikin-ashi technique. If the haClose is above haOpen, then a bullish sign occurs (white candle). If haClose is below haOpen, then a bearish sign appears (black candle). At first glance, Figure 1 shows that the heikin-ashi chart
looks more compact and smooth compared to the traditional chart. White candles display a rising trend, while black candles indicate a downtrend. Gaps, which occur frequently on the traditional OHLC chart, are not present because they are incorporated into the modified candles. Strong positive trends have
long white bodies with no lower shadows, while strong negative trends have long black bodies with no upper shadows.
When bodies become shorter, a weaker trend is anticipated (see mid-October and end of December). In the beginning of November, Canon weakened its uptrend and started a consolidation period with several small bodies with both long upper and lower shadows. A very small body with tall shadows on the first trading day in 2000 warned about a possible change of the rising trend. As consolidations contain several bodies with tall shadows, it is not safe to assume that the presence of a small body with tall shadows will indicate a change in trend. Figure 2 summarizes the five scenarios that can be identified on a heikin-ashi candle chart.
To give you an idea of how to apply the heikin-ashi charting technique, I will show you three examples using the Standard & Poor's 500 index (SP500-HA), the price of gold (XGLDHA), and Pfizer (PFE-HA). The heikin-ashi OHLC values were calculated as indicated in the sidebar and plotted. Each chart contains two candlestick subcharts: The top contains the modified OHLC values, while the bottom has the real values. Each number in the table in Figure 2 (1 to 5) applies to the chart whenever a relevant scenario appears. They are labeled in different colors to differentiate descending and ascending trends. For each chart I'll discuss how this technique can be used to either enter and stay on the right side of the trend, or avoid trading during periods of consolidations.
Figure 3 offers no doubt about the usefulness of this method, even for a novice: All trends are visible, with short consolidations marked as (4) occurring in February and July. Strong rising trends (2) were marked by long white candle bodies with no lower shadows, while strong falling trends (2) were accompanied by filled candle bodies with no upper shadows. Using the observations in Figure 2, note how the smaller bodies (3) in January 2003 warned about a weakening of the trend, and subsequently, a reversal (4). Trend changes (5) were pointed out by small bodies with longer shadows, but as an
exception, the reversal in March occurred without any such sign. Although a rising trend, the segment AB was composed of several short sections (normal trend, weakening, consolidation). It could also be seen as a normal ascending trend (1) due to a majority of white bodies.
If you have been trading Pfizer (PFE), you should be familiar with its behavior, which is highlighted in both charts in Figure 5: many small consolidations on the way both up and down. Gaps are not shown on the modified chart, which makes it easier to read. The small body with long upper and lower shadows (5)
confirms a change of trend in April. As shown on the daily chart, the longer trends are not continuous (as in the previous examples), but interrupted by small consolidations. In this case, it would be worthwhile to analyze weekly charts.
