Confirm Forex Momentum With Heikin

Ashi
Investors and speculators are always looking for an edge in determining the strength and direction
of trends. The Heikin Ashi application is one tool that may be able to provide this edge. Similar to
the Ichimoku charts, the Heikin Ashi has been a relatively unknown tool that has recently seen a rise
in popularity, even though it has been accessible since its introduction almost two decades ago.

In addition to showing the relative strength of a trend, the application also notes key turning points
in price action and reacts much like a moving average. Incorporating the overall session activity in a
single candlestick (open, close, high and low), the charting tool also "smooths" over erratic
fluctuations in the currency markets and omits spikes that may be sparked by volatility or jumps in
price. This allows chartists to obtain a clearer picture of what's going on in the market and to make a
more informed trading decision. Let's take a look at how the Heikin Ashi is calculated and how it
can be applied to forex trading. (For more insight, read Heikin-Ashi: A Better Candlestick and
Trading Without Noise.)

Defining the Heikin Ashi

Before we get into the actual application of the Heikin Ashi, let's dive into some logistics involving
the real meaning behind it. Usually a type of candlestick chart, the Heikin Ashi is available on some
charting packages as a separate indicator. This allows investors or speculators to make a side-to-side
comparison between the standard candlestick and the Heikin Ashi, allowing for a more cohesive
interpretation. In Figure 1, the chartist can see that the two are very similar but offer different
perspectives, as the Heikin Ashi indicator disregards market noise and concentrates on the smoother
trend of the underlying price action in the euro/U.S. dollar.
The reason the Heikin Ashi tends to be smoother is because instead of using a simple low and high
of the session to calculate individual candles, the Heikin Ashi takes the prices per bar and averages
them to create a "smoother" session. This is key because the currency markets tend to offer traders
more volatility and market noise in the price than other markets. Here is how each candle is
constructed:
Close = (Open Price + High + Low +Close) / 4
Open = (Open Price of the previous bar + Close Price of the previous bar) / 2
High = [Maximum value of the (High, Open, Close)]
Low = [Minimum value of the (Low, Open, Close)]
By plugging formulas into each individual session to construct consecutive candles, the chart
continues to be reflective of the underlying price action, isolating the price and excluding currency
market volatility and noise. The resulting picture gives the trader a more visually appealing
perspective, and one that can help in identifying the overall trend.

Now that we've established how the candles are calculated, here is how to interpret them:
Positive candles (blue) containing no wicks: There is strong uptrend momentum in the
session and it will likely continue. Here, the trader will have a hands-off approach to profits
while strongly considering adding on to the position.
Positive candles (blue) containing shadows or wicks: Strength continues to support the
price action higher. At this point, with upside potential still present, the investor will likely
consider the notion of adding to the overall position.
A smaller candle body with longer wicks: Similar to the doji candlestick formation, this
candle suggests a near-term turnaround in the overall trend. Signaling indecision, market
participants are likely to wait for further directional bias before pushing the market one way
or the other. Traders following on the signal will likely prefer confirmation before initiating
any positions.
Negative candles (red) containing shadows or wicks: Weakness or negative momentum is
supporting the price action lower in the market. As a result, traders will want to begin
exiting initial long positions or selling positions at this point.
Negative candles (red) containing no shadows or wicks: Selling momentum is strong and
will likely support a move lower in the overall decline. As a result, the trader would do well
to add to existing short holdings.
The Heikin Ashi will still take some time to master; however, once this is accomplished, the Heikin
Ashi will act to confirm the overall trend of the price action. Now let's see how it is used in market
opportunities.

Improve on Opportunities
With a smoother picture, sometimes a more simplified one, a speculator can improve on trading the
overall trend by combining the Heikin Ashi with multiple indicators. As with any other chart
application, it's better to find an indicator that works well with your individual trading style when
adding on the Heikin application. This will not only help traders to establish a directional bias, but it
will also clear up entries, support and resistance and offer further confirmation of the trade
becoming profitable. In Figure 2, the chartist is looking at a prime example using the Australian
dollar/Canadian dollar currency pair.
 Figure 2: A pivotal turn confirmed by Heikin Ashi

Taking a look at the price action, the Australian dollar weakened enormously against a rising
Canadian dollar, hence the downtrending channel. Reaching the psychological 0.8300 support, the
cross pair presents an opportunity to the speculator. Not only is the AUD/CAD pair testing the
support trendline at the 0.8300 level, the potential bottom coincides with the lower channel
trendline. Confirming the strength of such a barrier, we overlay the Heikin Ashi and focus on the
two dojis that have formed on the chart. The presented signal gives us the best confirmation in this
example, as the trade is calling out a long position in Figure 3.
 Figure 3: Two dojis scream out a probably long

Signaling a potential turn in the price action, the dojis set the trade up nicely. Next, an entry point
must be established. At this point, the best entry afforded, according to industry theory, is a break
above the high of the session at Point A in Figure 3. This will set the long buy order at 0.8400 with a
corresponding stop 2 points, for example, below the low of the session, at 0.8328. Theoretically, the
trade is looking to profit, not only on a retracement test of the upper trendline, but a potential break.
That's where the profits lie as the break above would create a longer term advance. The idea
coincides with what is being viewed on the Heikin Ashi. Over the course of the next month, with
the stop fully intact and untriggered as the price never trades back, the long position remains
profitable until the creation of another doji near mid month's time. Taking into account the close of
the session - including the doji, which is precisely set at 0.8554 - the trade has already profited by
154 points. Looking back, this is more than sufficient, as the risk/reward ratio is well above the 2:1
minimum prescribed. Subsequently, a trailing stop would be perfect at keeping profits close while
letting potential unfold in the coming weeks.
Breaking It Down
Let's take it down a notch and look into the steps of another example. Here, we'll reference a
textbook example in the New Zealand dollar/Japanese yen currency pair. Taking a look at the
overall price action, we see consolidation in the month of July on the longer term daily chart.
Applying the stochastic oscillator, we see a golden cross form (Point B), suggesting a near-term
uptick in Figure 4. (For more insight, see Getting To Know Oscillators - Part 3: Stochastics.)
1. Identify support or resistance: Although not a full requirement, this helps to establish a
viewpoint where a directional bias can be established. This will likely help in isolating
points of entry, assisting with stop placement and risk assessment. In the example, there is
ample support that is coming in at the 69.25 figure, offering a great opportunity for a long
trade.
2. Overlay the technical indicator: The stochastic oscillator assists in suggesting bidding
support as both indicators begin to form a golden cross. The cross at Point B confirms the
trade bias and isolates the point of entry.
3. Confirm with Heikin Ashi: Obtaining the entry point off of support and the technically
bullish crossover in the stochastic, the trader can confirm the strength of the nascent trend by
using the smoother based candles. In the visual example at Point C, the chartist can see that
the doji is indicative of the shift in momentum as sellers begin to exit the market.
Simultaneously, the following longer bodied candle signifies a stronger uptrend in buying.
4. Place Entry Order: Now, with the directional bias confirmed, the trader will do well to
place the entry five to 10 points above the doji session high. Although the order can actually
be placed at the high or any other position in the session, the placement in this case is in
order to capitalize on a breakout of price action (Point D). As a result, the entry is placed at
69.90. Placing the corresponding stop five points below the support will ensure a viable test.
Should the level be broken to the downside, the previous trade is negated on overriding
selling momentum. However, in this case, our indicators confirmed the directional bias,
profiting 360 points before topping out for the first time two weeks.
5.
Conclusion
As you can see, although still somewhat new to the currency market analyst, chartist or
trader/speculator, the Heikin Ashi is a viable tool that can help to confirm the momentum of a trend.
Additionally, similar to the moving average, the smooth calculation helps in isolating market
opportunities by removing the noise that will almost always lead a trader astray and clog up the
technical perspective. As a result, by using this application and keeping in mind its longer term uses
and advantages, any participant in the currency market can apply and reap the benefits of such a
simple tool while keeping a finger on the detailed pulse of the market.

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