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Heikin-Ashi candlesticks are a slightly different way of viewing the markets. In this article, I will show how they are used as part of a profitable trading strategy.
The image below shows the DJIA with standard Japanese candlesticks.
This next image below shows the DJIA over the same period using Heikin-Ashi candlesticks.
The two images are quite similar but note how the trends are clearer on the Heikin-Ashi chart. This is because we calculate Heikin-Ashi candles based partly on the average price and partly on the price of the preceding candle. The effect of this is to smooth the candles and gloss over minor moves in the opposite direction to the primary trend.
The advantage of Heikin-Ashi candlesticks is that they make the trend clearer and help nervous traders (which is all of us sometimes!) remain with the dominant trend. However, it is important to remember that when the market does change direction Heikin-Ashi candles react more slowly.
Heikin-Ashi Trading Strategy
In this strategy, I used historical data from the EUR/USD pair on the 4-hour timeframe. The historical data was from 2000 – 2014.
The strategy I backtested is:
- Trade Long when Heikin-Ashi turns positive and MACD is below 0
- Trade Short when Heikin-Ashi turns negative and MACD is above 0
- Close Long when Heikin-Ashi turns negative
- Close Short when Heikin-Ashi turns positive
I used a stop-loss and profit target of the ATR * 10.
I did a second backtest which included a trailing stop of the ATR * 1.
Additionally, I only took trades that occurred during the European trading session. The European session includes the very end of the Asian session and also the US morning session.
Finally, I wanted to take account of the summer slowdown in the financial markets an so excluded the months of July and August from my analysis.
Tradinformed Backtest Models
If you want to take your trading to the next level, the most important step is being able to test your strategies. Once you can do this, you will be able to discard the useless advice and focus all your attention on what really works.
I backtested the trading strategy using a Tradinformed Backtest Model. This is a spreadsheet that can be used to test all sorts of trading and investment strategies. Excel is a great tool to use for backtesting because it is very accessible and allows testing of quite complex strategies.
The results of the first backtest were:
|Gross Winning Trades||$206,109|
|Gross Losing Trades||$-177,809|
|Largest Winning Trade||$6,947|
|Largest Losing Trade||$-3,696|
The results of the 2nd backtest, including the trailing stop were:
|Gross Winning Trades||$173,415|
|Gross Losing Trades||$-139,753|
|Largest Winning Trade||$5,249|
|Largest Losing Trade||$-3,548|
The above results are pretty encouraging to me. They show that the Heikin-Ashi candles can be profitable over a long period. They produce a decent win percentage for a trend following strategy and in particular show a low drawdown. For many traders, this is a key aspect. It is hard to follow any strategy that has big swings in profitability.
This strategy is designed to highlight how Heikin-Ashi candlesticks are helpful for traders looking for trend following opportunities. They are easy to read and understand. They can be combined with other indicators to make them more effective.
My fallback information source for anything related to Japanese Candlesticks are the books by Steve Nison. I have his classic Beyond Candlesticks: New Japanese Charting Techniques Revealed and I refer to it often. If you are interested in learning more about candlesticks, this is an excellent place to start. The book covers patterns as well as other fascinating Japanese trading systems like 3 LIne Break, Renko and Kagi Charts.
I have recorded a YouTube video giving more information about the candlesticks and the backtest spreadsheet.