Heikin Ashi Technique for Crypto Trading
What is the impact of Heikin Ashi Technique on crypto trading?
The cryptocurrency markets are known for their extreme volatility. Prices can swing wildly within a short period, presenting both risks and opportunities for traders. While the potential rewards of crypto trading are enticing, navigating such turbulent waters requires a steady hand and a reliable analytical framework.
Technical analysis offers traders various charting tools and indicators to objectively identify trends and interpret market behavior. Among these techniques, the Heikin-Ashi candlestick stands out for its unique approach to filtering price noise and highlighting trends.
This article will provide a comprehensive overview of how the Heikin-Ashi technique can be applied for cryptocurrency trading. We’ll explore what Heikin-Ashi candles are, the benefits they offer, and how to incorporate them into trading strategies. Sample charts will be used to demonstrate key concepts in a visual manner.
Key Takeaway
- Heikin-Ashi candles smooth price action by averaging data points, reducing noise and highlighting trends in crypto charts.
- Benefits include clearer trend identification, potential for early reversal signals, and a simpler trading view.
- Heikin-Ashi can be used for trend-following strategies (buying during uptrends, selling during downtrends).
- Certain candlestick patterns on Heikin-Ashi charts, like Doji and Engulfing, may signal trend reversals.
- Heikin-Ashi works well when combined with other technical indicators for confirmation before entering trades.
What is Heikin-Ashi?
Heikin-Ashi, meaning “average price” in Japanese, is a variation of the traditional candlestick chart. It was developed by Munehisa Homma, a successful grain trader from the 18th century, as a way to filter out noise and see the true trend more clearly.
Unlike standard candlesticks that use the open, high, low and close of each period to form the candle “body” and “shadows”, Heikin-Ashi candles take a weighted 4-period average of these values.
Specifically, the Heikin-Ashi Open is calculated as the average of the current period’s open and the previous period’s open, high and low. The Heikin-Ashi High is the maximum of the current high and previous close. The Heikin-Ashi Low is the minimum of the current low and previous close. And the Heikin-Ashi Close is the average of the current close and previous close.
This averaging method results in a smoothed-out price action that is lagging a single period behind. It reduces the impact of temporary price fluctuations and outliers, making it easier to identify the general direction of the trend.
Related: Renko Chart: Definition, How to Use Them In Crypto Trading
Benefits of Using Heikin-Ashi for Crypto Trading
Here are some of the benefits of Heikin-Ashi for Crypto Trading:
Reduced Market Noise
The volatility inherent to cryptocurrency markets makes price charts cluttered with noise, gaps, and whippy movements on small timeframes like 5-minutes or hourly. By averaging price values over a short period, Heikin-Ashi filters out this noise, leaving a clearer view of the underlying trend. This can help prevent traders from taking premature actions based on insignificant intra-period price swings.
Enhanced Trend Identification
With noise removed, trends stand out more prominently on Heikin-Ashi charts. Uptrends will show a consistent series of green candles, while downtrends exhibit red candles. Range-bound periods also become easier to recognize. The smoothed data simplifies the process of determining the current market bias.
Potential for Early Signals
Some studies have found that certain reversal patterns like engulfing candles can be spotted earlier using Heikin-Ashi versus standard candles. This is because averaging incorporates a bit of future price data into the current candle. As a result, trend changes may be hinted at one period in advance. Even a small head start could allow traders to enter positions sooner.
Using Heikin-Ashi for Crypto Trading Strategies
Now that we understand the construction and benefits of Heikin-Ashi candles, let’s explore some practical ways to incorporate them into actual trading strategies.
Trend Following
One of the simplest yet most effective approaches with Heikin-Ashi is trend following. Traders can look for periods of consecutive green or red candles to identify uptrends and downtrends respectively. Within those trends, longer candle bodies and shorter shadows indicate strong momentum that is likely to persist.
For example, four or more green candles in a row would suggest an uptrend is in place. A trader could then buy on pullbacks, targeting moves to a new high. Conversely, a string of red candles implies a downtrend, where shorting rallies or selling into strength may prove fruitful.
Identifying Reversals
Certain candlestick patterns have been shown to potentially foreshadow trend changes when spotted on Heikin-Ashi charts. Two such formations are Doji candles and Engulfing patterns.
A Doji shows indecision, where the open and close are nearly equal. After an extended trend, it hints the move may be exhausted. An Engulfing pattern consists of a large real body completely engulfing a smaller body of the prior candle. It implies a shift in control from buyers to sellers or vice versa.
Traders can watch for these signals at potential support/resistance zones to anticipate reversals. For example, a bearish Engulfing candle under support could be a sell set-up. Proper confirmation, like a close below the low of the Engulfing candle, would trigger entries.
Combining Heikin-Ashi with Other Indicators
Heikin-Ashi works well in conjunction with other technical tools. It can be used to determine the general bias and potential reversal signals. Then traders may wait for confirmation from secondary indicators like moving averages or momentum oscillators before taking action.
For instance, a bearish Heikin-Ashi candlestick pattern forming near a major resistance zone could be an early warning. But traders may only short once price closes below a 20-period exponential moving average for extra validation. Combining multiple factors in this manner helps reduce uncertainty.
Step-By-Step Construction of Heikin Ashi Bars
Heikin Ashi bars are a popular tool among traders for identifying market trends and smoothing out price movements, making it easier to interpret charts. Here’s a step-by-step explanation of how these bars are constructed, using a visual example to clarify each step.
Step 1: Calculation of Heikin Ashi Values
Heikin Ashi bars use average price components from the current and previous bars to create a smoothed candlestick. The formulas for each component are:
Close: The average of the open, high, low, and close prices of the current period.
Open: The midpoint of the previous bar’s open and close.
High: The maximum value among the current high, open, and close.
Low: The minimum value among the current low, open, and close
Step 2: Plotting the Bars
Once you have these values, you can plot the Heikin Ashi bar:
- Open: Start the vertical line at the calculated open value.
- Close: The body of the candlestick ends at the calculated close. The body is filled if the close is lower than the open (bearish), and hollow if the close is higher (bullish).
- High and Low: The highest and lowest values reached during the period determine the upper and lower shadows (wicks) of the candlestick.
Step 3: Visual Example
Let’s consider a specific candlestick:
- Original OHLC data: Open = $100, High = $105, Low = $95, Close = $103
Using the Heikin Ashi formulas:
- Heikin Ashi Close = $(100 + 105 + 95 + 103) / 4 = 100.75$
- Heikin Ashi Open (assuming the previous Heikin Ashi close was $98 and open was $96$) = $(96 + 98) / 2 = 97$
- Heikin Ashi High = $\max(105, 100.75, 97) = 105$
- Heikin Ashi Low = $\min(95, 100.75, 97) = 95$
Visual Representation
The Heikin Ashi candlestick for these data points would look like this:
- Open at 97
- Close at 100.75
- High at 105
- Low at 95
The body is hollow (indicating a bullish movement since the close is higher than the open), starting at 97 and ending at 100.75, with a wick extending from 95 to 105. This visualization helps in understanding the smoothed trend direction and reduces the effect of minor price fluctuations, which is why Heikin Ashi is favored by traders looking to follow the trend.
Limitations of Heikin-Ashi
While Heikin-Ashi offers advantages, it also has limitations traders need to be aware of:
Loss of Price Data
By averaging in prior data, some actual price information is lost or obscured. Extreme candle highs/lows may not be reflected on the chart.
Lagging Indicator
Since it references the previous period, Heikin Ashi reactions to news or rapid price changes can lag slightly versus standard candles. It is not ideal for scalping very short timeframes.
Not a Crystal Ball
At the end of the day, Heikin Ashi is still just a technical analysis tool. Like any other indicator, it does not guarantee future price action and is not a substitute for sound risk management. Unexpected events can always cause surprises.
Risk Management Fundamentals
Effective risk management is crucial for any trader, especially in the volatile crypto markets. A few key concepts to keep in mind include:
Stop Losses
Set predefined exit points to cut losses on losing trades. For example, place a stop loss 3-5% below entry on a long position. This prevents small losses from becoming big losses. Stops can be trailed up as the trade moves in profit.
Position Sizing
Allocate no more than 2-5% of total capital to any single trade. This limits risk if one trade goes against expectations. Capital should also be distributed across multiple trades/assets when possible to reduce reliance on one position.
Trade Journal
Record every trade details like entry, stop, target and notes. Note what went well and areas of improvement. Analyze past performance to refine strategy and psychology. A journal builds accountability and highlights what works in the long run.
Bankroll Management
Start with a trading stack of at least 20x the average risked per trade. Preserve capital for the long haul by not over-leveraging and quitting while still ahead of losses. Recoveries take time but are possible with discipline.
Mental Discipline
Have a plan and stick to it without getting swayed by emotions or chasing losses. Cut winners early and sit on hands during uncertainty. Trading requires an objective, level-headed approach.
Reputable Crypto Exchanges & Charting Platforms
Some reputable cryptocurrency exchanges that allow charting with Heikin Ashi include Binance, FTX, and Kraken. Each has a large selection of coins and decent trading tools.
For advanced charting, TradingView is the most popular free platform. It supports Heikin Ashi as well as a huge range of indicators, scriptable studies and drawing tools. Charts can be viewed on any timeframe.
For mobile, CryptoPro is an excellent app. It syncs with many top exchanges and allows tracking prices and setting alerts on the go. TA functionality includes Heikin Ashi and technical studies.
Coinigy is a desktop platform that connects directly to exchange APIs. This gives traders direct access to their exchange accounts without needing the exchange site. Heikin Ashi and custom scripts can be utilized.
For those wanting all-in-one crypto solutions, exchanges like Binance and FTX also have robust charting built right into their trader interfaces. Heikin Ashi is natively supported on both.
Potential Crypto Trading Strategies
Some strategies that can incorporate Heikin Ashi include:
Swing Trading: Identifying potential reversals and continuations of intermediate trends lasting several days to weeks. Positions are held longer term, taking advantage of macro price swings.
Breakout Trading: Watching for consolidations and false breakouts on Heikin Ashi, then entering in the direction of valid breakaway moves. Targets are 1:2 risk-reward areas.
Range Trading: Defining support/resistance levels that coins often bounce between. Going long on dips to support and shorting rallies to resistance for quick intra-range trades.
Trend Following: Riding major uptrends or downtrends by entering on pullbacks shown by Heikin Ashi trend lines or moving averages. Profits taken in increments as trends mature.
Scalping: Trading very small 5-15 minute charts, looking for quick reversals or continuations signaled by specific Heikin Ashi candlestick patterns near support/resistance.
Conclusion
In highly volatile cryptocurrency markets, filtering noise and identifying trends clearly is crucial for traders. The Heikin-Ashi technique developed by Homma was designed precisely for this purpose. By smoothing price data yet still retaining the general bias, it simplifies technical analysis. Signals like trend continuations, reversals, and consolidations stand out more prominently on Heikin-Ashi charts.
When incorporated judiciously into a trading plan alongside other indicators and price action techniques, Heikin-Ashi shows promise. It warrants an objective test run with paper trading or a demo account before risking real capital based on its signals. Traders should also be aware of its limitations as a lagging, less precise analytical tool.
