One little tool in my bag of tricks I use when analyzing the market or stocks is the Heikin-Ashi chart.
I’m honestly surprised there isn’t more discussion on this topic and I don’t see more people using it or posting HA charts. I was going to link to the definitive Heikin-Ashi trading book at Amazon but I’m not sure it even exists.
Maybe I should write one, “Trade Like A Cat Using The Heikin-Ashi Chart”.
But anyway the Heikin-Ashi chart is useful for spotting trend changes. It doesn’t replace normal charts – it compliments them. It’s just a different way to look at the price action and is based on “average price”.
According to Stockcharts.com Heikin means “average” and “ashi” means “pace”. I like the chart because it simplifies things when it comes to observing the prevailing trend and spotting areas where a trend change may be occurring.
Which brings me to the current SPX chart. Right now I’m seeing “warning signs” on the Heikin-Ashi chart because the last few bars have turned red, after the big run-up. In a strong trending market you will see a series of green or red bars (or candles) with perhaps one or two “opposite bars” but then the trend resumes.
The length of the bars is important as well as the “shadow” but I’ll save all the detailed stuff for my book.
Here’s the SPX chart right now. (click for full-size)
As we see, the recent rip-your-fur-off rally is showing signs of stalling out and we see 4 red Heikin-Ashi bars in a row. Now they aren’t “long body” bars (yet) so this is just a warning sign that a trend change could be starting. My thinking is that caution is advised here until / unless a green HA bar prints on the chart.
The formula for calculating Heikin-Ashi bars according to Investopedia is:
Close = (Open+High+Low+Close)/4
Open = [Open (previous bar) + Close (previous bar)]/2
High = Max (High,Open,Close)
Low = Min (Low,Open, Close)
Also notice I use the DMI “Directional Movement Indicator” in conjunction with the Heikin-Ashi chart. I use a DMI 10 and I like the fact that this chart configuration is fairly simple to interpret.
When the DMI lines cross it indicates a potential change in trend – simple as that. Of course we have no way of knowing if it’s the start of a major trend or simply a small counter-trend move.
Again, I’m not going to get into a bunch of specifics because the idea is to provide a slightly different way of looking at things and you can take it from there.
Just to reinforce the idea of how helpful the Heikin-Ashi chart can be in spotting trend changes, take a look at this chart of TSLA.
One thing I want to mention is that I have my Heikin-Ashi chart set to color the bars based on “open vs. close”. This is different from the standard format. I believe the standard DMI is 14 but I use a 10 instead – it’s a bit faster.
As you probably know, I’m a simple cat that likes simple things so the red / green nature of the HA chart makes it easier to see the prevailing trend.
Also there are no gaps on a Heikin-Ashi chart.
The Heikin-Ashi chart with a DMI helps me see things I might not see on a normal OHLC or candlestick chart so I like to use it as an “additional look” for both stocks and the market. Most of all it helps identify inflection points where a change in trend might be happening.
When the bars transition from primarily green to more than a couple red bars, the trend might be changing.
Going into next week, given the fact the SPX has 4 red bars (even though they aren’t wide-body bars) I’m thinking it might not be a bad idea to “henceforth err cautiously of shares” until or unless we see a green bar print on the Heikin-Ashi chart.
As much as I hate to admit it – I can’t always just rely on instinct.