How to Identify Profitable Chart Patterns

How to Identify Profitable Chart Patterns

Is the human mind programmed to look for patterns, even when there are none?

If the stock market is like a casino, ruled by chance, there would not be any patterns for to look for. If however, the whims of its players do influence the price movements of stocks, commodities, currencies or market indices, there is perhaps a chance that a trader may look for profitable patterns in apparently random movements. In an effort to not miss any such patterns, traders have been trying various chart analysis tools to their advantage.

Charting price movements is one efficient way to look for those patterns, and the now popular Heikin Ashi charting technique goes one step further in simplifying those chart patterns. This technique modifies the normal candlestick chart to rather convenient and easy-to-look-at candles by manipulating the open and close values of the charting data.

So, how would you manipulate the available open, high, low and close price data of a stock, commodity, currency or index you want to trade to reflect on your Heikin Ashi chart?

Begin with the data for day-1 by leaving the open, high and low values as they are on your charting software, as in a spreadsheet, but change the day-1 close to read as the average of the day’s high, low and twice the actual close value, to give slightly more weight to the close of the day. This becomes the ‘haClose’ for the first day’s candle on your chart. For the next day, simply calculate the average of the previous haClose and the open, to represent the ‘haOpen’, while the haClose for the day is again calculated as the average of the actual values of high, low and two closes. The high and low values in the Heikin Ashi chart should also be adjusted to make sure that they are the high and low for the day to include the haOpen and haClose calculations as well.

As you continue to manipulate the actual OHLC data for many more days in this way, and chart the data as a Heikin Ashi chart, you would notice a marked improvement in the visual handle you now have on the price pattern. This chart clearly does away with much of the ‘noise’ as spikes and shadows are filtered. To further simplify the chart, you might even eliminate the remaining shadows of highs and lows by replacing the ‘high’ and ‘low’ by a 5-day moving average of the haOpen and a 5-day moving average of the haClose respectively. With this little maneuver, bullish and bearish candles would sharply stick out and reveal the existing prominent trend in the stock price movement.

Here is how such a chart for the DJIA may look like:

Heikin Ashi  DJIA Chart Patterns

Now that you have a very fine looking chart, how would you profitably trade the prevalent bullish or bearish patterns? The most striking feature of the Heikin Ashi chart is the haOpen which is fixed for tomorrow as it is an average of the previous day’s haOpen and haClose values. This feature is the tool that would help you in fixing your triggers and your strategy for the next day’s trades.