The Search for the End of a Trend with Heikin Ashi Bars

Watching the financial media for advice on when a trend may be ending is like having a smooth connecting flight at one of the world’s busiest airports—neither is likely to happen. By the time a bear market is declared, the market has already fallen more than 20%. So much for timely advice. The trick is to use tools that may provide an objective perspective for a trend change while it’s occurring, not well after the fact. And that can be a tall order because no method is foolproof by any means. But some techniques can give you just enough information to help you make an informed decision. One is the heikin ashi (sometimes spelled heiken ashi) charting technique. 

What Is Heikin Ashi?

In a nutshell, heikin ashi is a charting style similar to candlestick charts. But there are some differences between the two. Instead of using the prevailing bar’s open, high, low, and close to build the bar, the heikin ashi candle is created by combining the midpoint of the previous bar with the open, high, low, and close of the prevailing bar. A red bar means the average closing price of the prior six bars is in the lower 50% of its range, indicating a bearish bias. The opposite is true of the green bars. 

Luckily you don’t need to know more about the mechanics because you can pull up a heikin ashi chart on the thinkorswim® platform from TD Ameritrade. From the Charts tab, bring up a chart, then select Style > Chart type > Heikin Ashi. Heikin ashi charts are represented by red and green bars (see figure 1). And relatively speaking, heikin ashi charts appear to be smoother than candlestick charts. There are no price gaps on the chart. 

Now that you know how the chart looks, it’s time to learn how you can apply heikin ashi to your trading. 

Putting Heikin Ashi to Work

Heikin ashi charts can be used to identify potential trends or trend reversals. What’s nice about this indicator is it takes into context a group of bars—not just a single bar. A group of bars can help confirm a trend change, rotation from a bullish bias to a bearish bias, and vice versa. A single bar can be an anomaly. And changes from long-range candles to short-range ones with wicks or tails on both sides can indicate uncertainty or indecision. This could happen during a turning point and during pullbacks.

In the chart in figure 1, at first glance you can see that a group of long green bars moving up indicates an uptrend, whereas a group of long red bars moving down indicates a downtrend. But you can take it one step further by creating a heikin ashi moving average strategy using moving average crossovers. One way to do this is to apply two exponential moving averages (EMAs) to identify trends or trend reversals. In figure 1 there’s an eight-period (yellow line) and 21-period (purple line) EMA overlaid on the chart.   

How to Read Heikin Ashi Charts

As long as a group of green bars and the two EMAs are moving up with the shorter one above the longer one, the uptrend is likely intact. But can you get a “heads up” that the heikin ashi is showing a potential trend reversal? An initial signal may be the formation of a group of opposite-colored bars. Next, you could look to see if the eight-period EMA starts to roll over and move below the 21-period EMA. If that happens, you may want to think about tightening your stops.

Let’s look at the chart in figure 1 as an example. 

At point #1 there is a choppy trend up, and we see a couple of red bars develop. While these long red bars were developing, the eight-period EMA started to move sharply lower. This should have raised a red flag that a heikin ashi reversal may be taking place. If you have a long position open, now might be a good time to think about where you want to place a stop.

Once the eight- and 21-period EMAs cross to the downside, the trend may be over. If you haven’t been stopped out at this point, you might consider exiting the trade. This is useful because it indicates an overall change in trend, which may not be an appropriate time to add to a position or double down—it’s potentially a time to clamp down on money management techniques.

At point #2 it looks like a new uptrend might be starting. After a group of short-range bars formed, the eight-period EMA crossed above the 21-period one, and a group of green bars started forming. But not too long after the crossover, there was a series of red bars in succession. Is this a heads up that the trend is suddenly over? Note that during this time the eight-period EMA didn’t roll over, so you may not need to raise your stop.

Only at point #3 does the eight-period EMA cross below the 21-period EMA. Prior to the crossover, the bars were relatively short, indicating some uncertainty. A support level would be helpful in confirming the trend change. Once price falls below the support level and the EMA crossover takes place, you might want to consider initiating your money management techniques.

While technical analysis cannot predict or guarantee the future performance of any security or strategy, heikin ashi bars may help you stay with the trend by eliminating price noise associated with gaps and intraday movement. But by using indicators such as moving averages on heikin ashi charts, you may get some clues about when a trend reversal might take place.  

Past performance of a security or strategy does not guarantee future results or success. 

While these principals are the foundation of technical analysis, other approaches, including fundamental analysis, may assert very different views. TD Ameritrade does not recommend the use of technical analysis as a sole means of investment research.