Magic Heikin Ashi What's it for?
To better understand what Heikin Ashi is, let's first introduce the concept of market noise. Imagine that your neighbors love to make noise. How do you feel about this? I'd say that it all depends on the noise level. If it's not loud, then you can ignore it, but if the neighbors are really raising the roof, then you'd be really irritated and unhappy. Naturally, you want to get rid of this noise.
You might not believe it, but there is also noise on the market. Let's say that the price for the EUR/USD pair is rising, and the trend is ascending or bullish. Unfortunately, uninterrupted rises or falls are very rare on the market. Alas, prices don't move along a straight line, but along a curved or broken one. Price movements therefore look more like waves. Charles Dow, one of the founders of the foremost US index, the Dow Jones, also compared price movements to waves and said that the market has "high" and "low" tides.
If the price is currently dropping, that doesn't mean that the drop will continue. It's entirely likely that this is a low tide that will be followed again by a high tide, even stronger, and the price will rise again. And vice versa, if the price is rising, it's quite possible that this is just a small low tide before a down wave. These low tides on the market are called corrections. Unfortunately, these kind of tides often make it hard to understand the chart, i.e., they create irritating noise that makes it hard to think. Of course, you want to get rid of the noise, and Heikin Ashi helps you do just that.
How is a Heikin Ashi plotted?
Heikin Ashi is plotted by averaging prices. If our EUR/USD currency pair is rising, but there is a brief "low tide" or correction, then by averaging the price, we'd smooth out the correction, i.e., get rid of the noise. If you see a series of candlesticks on a Japanese candlestick chart and their color periodically changes, then the Heikin Ashi most often represents a sequence of red or green candlesticks that always move in the same direction. So don't confuse a Japanese candlestick chart with the Heikin Ashi. A candlestick on a Japanese candlestick chart could be red, but on the Heikin Ashi you'll see that it's only one of the green candlesticks at the top and vice versa (see the figure).
This is the same currency pair (in our case GBP/JPY) over the same timeframe, but the top chart represents a Japanese candlestick chart, and the bottom one represents a Heikin Ashi.
How do you "read" a Heikin Ashi?
Note what Heikin Ashi candlesticks look like - quite often there is no shadow on one side of the candlestick, while it is extended on the other side. By the way, did you notice which way the shadows are pointing? Right - in the direction of the trend. That is, if, for example, a Heikin Ashi is rising, then there is usually no bottom shadow, but there is a top shadow. If the Heikin Ashi is falling, then everything is the opposite - there is no top shadow, but there is a bottom one.
Next, watch how the Heikin Ashi behaves before the green candlesticks change to red or the red to green. The body of the Heikin Ashi gets small, while shadows appear on both sides, and they are often long.
So it turns out that we can interpret Heikin Ashi candlesticks this way:
- A green candlestick with no bottom shadowmeans strong upward movement.
- A green candlestick with a shadowusually occurs at the beginning or the end of upward movement.
- A candlestick with a small body and both shadows longis a warning of a possible trend change
- A red candlestick usually occurs at the beginning or end of downward movement.
- A red candlestick with no top shadowmeans strong downward movement.
Heikin Ashi: is it a chart or not?
It's not entirely correct to call the Heikin Ashi a chart. It's more like an indicator of a general trend. Unfortunately, you can't open trades using just Heikin Ashi, since each new Heikin Ashi candlestick is calculated using the average prices that were already on the market, so the indicator is "trailing." That is, it's like calling the police after your neighbors have quieted down. Of course, its better if the police see it with their own eyes, instead of you trying to explain it to them. So you need to combine the Heikin Ashi with other so-called technical analysis tools.